Today is US Federal Reserve day as we wait to see what the world’s main central bank has to say for itself and what policy actions are on the way. There are two themes to this and the first is that it is setting policy for the world’s largest economy and ch-ch-changes as David Bowie would say are on their way.
The New York Fed Staff Nowcast stands at 8.6% for 2021:Q1 and 4.0% for 2021:Q2.
News from the JOLTS, PPI, and CPI releases was small, leaving the nowcast for both quarters broadly unchanged.
As you can see the US is on course for not only a good first half to 2021 if the New York Fed is right but looks set to outperform its peers. The numbers are annualised so for those not used to the system divide by four. Whilst the numbers were unchanged on the week they have been improving as this year has progressed as the forecast for the first quarter was 5.22%.
At those rates of growth the US economy will soon be back to pre pandemic levels.
Real GDP decreased 3.5 percent (from the 2019 annual level to the 2020 annual level), compared with an increase of 2.2 percent in 2019. ( US BEA)
So it willbe back and growing although it will take some extra time to get back the US $686 billion of lost output last year. But the US economy seems to be shrugging it off at a relatively fast pace. For those wondering if the last quarter of 2020 is annualised US GDP is US $21.5 trillion.
Inflation
This is a more awkward issue on several counts. It starts simply as the PCE or Personal Consumption Expenditure index was at 1.5% in January or below target and remember these days they are happy to go above target.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longerrun goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation
expectations remain well anchored at 2 percent.
So in their terms they have scope to push it higher with a cap maybe not appearing until 3%. This leaves them with a real oddity because they will be pushing for something that they admit on their website hurts people and especially the poor.
It is understandable that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.
They get pretty much a free pass on this from the media. Also there is another influence which is back to the Imputed Rent game. They estimate inflation in the cost of owner-occupied housing via the rents they do not pay. That category is 19% of the index but includes utilities and those who do rent. So let’s say the imputed number is 10% that makes a difference if you go from rental inflation which has been 2-3% to house price inflation which is 9-10%
Also the Fed is supposed to look forwards and doing so in a strong economy brings inflation issues and we can see examples of that around with the new higher oil price leading the way. At US $68.40 a barrel of Brent Crude Oil is 127% higher than a year ago. Copper futures at US $4.09 are up just under 70%. There are signs that this is affecting what people think.
The February 2021 Survey of Consumer Expectations shows sharp increases in the outlook for growth in the cost of rent and gas, with both series reaching new highs. The median expectation regarding changes in the cost of rent increased to 9.0 percent in February from 6.4 percent in January. Similarly, the median year-ahead expected change in gas prices jumped to 9.6 percent from 6.2 percent over the month. The short-term inflation expectation edged up to 3.1 percent, its highest level since July 2014. ( NY Fed)
Also I noted that in spite of the economic growth the survey suggests real wage falls which is the opposite of the official data.
After remaining flat at 2% for the past seven months, median one-year-ahead expected earnings growth increased to 2.2% in February, driven by respondents with more than a high school education. The overall median remains well below its year-ago level of 2.6%.
The problem with the official data is that it has seen more lower paid workers lose their jobs and thus the average has risen.That can happen with nobody getting a pay rise.
Financing the US Government
This is an area which has got more problematic by the day. Like so many central banks the US Fed has ended up implicitly financing its government. It has not been direct monetary financing but so many bonds were bought it meant that bond yields plunged and governments could issue debt very cheaply. The US ten-year yield fell to 0.5% as the Fed bought bonds Kaiser Chiefs style.
Come back stronger than a powered-up Pacman
But now the situation has been described well by Robin Brooks.
Fed QE is running at a pace of 5% of GDP in 2021, while the fiscal deficit will be at least 15%, leaving a 10 percentage point funding gap. So the bond market sell-off isn’t just about “overheating.” It’s about how high yields must go to make US debt an attractive investment…
As I type this the US ten-year yield is 1.63% so yields have gone higher in response to this new situation. This means that the expenditure and deficits are starting to get expensive.
In the U.S., the 2020 fiscal response amounted to $3.3 trillion. Current Covid support approved in late 2020 and proposed spending by the new U.S. administration could add up to another $2.8 trillion to the fiscal bill as of February 2021. And even more is likely on the way in coming years. ( BlackRock)
As you can see we may find ourselves discussing debt costs again,something which some assured us we would not. But the Fed must be under pressure from Janet Yellen at the US Treasury and remember it is already buying US $80 billion a month and half that rate for mortgage backed securities.
For the US economy there is also the impact of the thirty-year yield on fixed-rate mortgages. It is now 2.39%.
Comment
There is a good news story here which is the expected recovery of the US economy which by its size will help others.
The U.S. international trade deficit increased in 2020 according to the U.S. Bureau of Economic Analysis and the U.S. Census Bureau. The deficit increased from $576.9 billion in 2019 to $681.7 billion in 2020, as exports decreased more than imports.
For the US Fed things are more awkward because under past central banking theory they should be singing along with Billy Ocean.
When the going gets tough
The tough get going
When the going gets rough
The tough get rough
Hey, hey,…
The issue is that they have been allowed to get away with something. The concept of independent central banks was that they would be able to make difficult decisions in a way politicians proved unable. That hits several problems now starting with the fact they have become politicians. Next is the way they are supposed to look around 2 years ahead but have managed to shuffle that unopposed to looking at the hear and now. Hence they should be thinking about taking away the punch bowl but as a consequence of their actions they cannot. Indeed things have got really perverse as we see to have interest-rate cuts in the future in response to current expectations!
The Market Is Now Pricing Almost 3 Hikes by the End of 2023, up From 1 at the January Meeting ( @PriapusIQ)
Can they hike then? It is all a gamble on economic growth versus inflation and bond yields. The UK tried it in the early 70s and it backfired.
In terms of the world issue with it being the main central bank there have been elements of a squeeze as it is starting with countries which borrow in US Dollars.That has got more expensive. But there is another issue if the US Fed cannot stop QE what chance does anyone else have?
Notayesmanseconomics's Blog 
The lies used to justify stuffing trillions into the banks because of poor economic circumstances will not do if we go into economic boom, so therein lie the horns of a dilemma for the fed & other CBs:
1) Do they find new lies to continue funnelling money into insolvent banks?
2) Do they do everything in their power to end economic recovery to continue as at present?
As Forbin would say, “Rule of the people by the banks, for the banks.”
new one ? why ? MSM havent twigged the old ones yet !
Shaun,
Further US Gov stimulus will need support from Republicans so may not be forthcoming leading to a . delay in a full economic recovery. Housing seeing a K recovery as condos out of favour whilst high demand for single family housing according g to Wolf St blog.
Hi Chris
Maybe it is too easy. Housing starts were weak earlier but it is also true that February had poor weather. But we learnt this evening that the US Federal Reserve has no intention of reduction in its stimulus effort any time soon.
Hello Shaun
re “They get pretty much a free pass on this from the media.”
Well thats a sign of the times , milli second attetion spans on Twatter and Farce book compounded with the likes of tik(ed) -off . Kids stuff , I stay away from it but these days even so called professional sites like linkedin are infested with sales trash and the me-me Kulture.
Frankly todays journalists can be rightly accused of scribble …… if they could remember where they put their crayons down.
Forbin
https://www.gocomics.com/pearlsbeforeswine/2021/03/07
https://assets.amuniversal.com/95af3a5044c00139469c005056a9545d
Hi Forbin
The debate post the Fed announcement was that fewer Fed members than expected suggested they would raise interest-rates in 2023.But that is the wrong way around as they are supposed to lead events by 2 tears not lag them! Who can say with any real certainty how 2021 will end? Thus of all the times you can say would you would do 2 years ahead this is not it.
But the circus must keep performing…..
Forbin: “Farce book” is a new one on me. I like it a lot.
Great blog as usual, Shaun.
Aside from the main thrust of your blog, you do err, in a sadly all too common way, in calling the US “the world’s largest economy”. It lost that title in 2014, under the Obama-Biden regime, and if one can believe the forecasts of the IMF, China will cement its lead between 2021 and 2025, as China is projected to continue to have a much higher growth rate than America over this period. Using GDP on a purchasing power parity (PPP) basis, the Chinese economy is actually bigger than all three USMCA countries (US, Mexico and Canada) combined. There are different measures of GDP on a PPP basis around, and they do give slightly different rankings, but the World Bank and CIA World Factbook estimates also agree that China is number one and the US is number two. The number three country, India, is still a long way from being able to challenge America for runnerup position.
There are any number of accessible studies on why it makes sense to rank countries’ economies using GDP on a PPP basis and not on nominal GDP estimates adjusted to US dollars using exchange rates. A good British paper is Richard Connolly’s 2019 study “Russian Military Expenditure in Comparative Perspective: A Comparative Estimate.” Contrary to the fantasies perpetuated by people like H.R. McMaster, Trump’s former National Security Advisor, who really should know better, Russia’s economy is not about the same size as its Texan counterpart. Connolly’s data relates to 2018, but based on its Russia had the sixth largest economy in the world, and the second largest in Europe (just behind Germany in both categories) and those rankings haven’t changed since. Also, contrary to the blatherings that US military spending exceeds that of the next eight to 10 countries combined, Connolly concludes that US military spending barely exceeds spending by China and Russia combined. So the failure of people to think in PPP terms has ramifications beyond the economic, and imperils the liberal democracies.
Hi Andrew and thank you
You make a good point as using exchange-rates to compare economies has 2 big flaws.They move so which is the right one?Also you could never sell the whole economy at that price. It leads in my part of the world to various exchanges of position between the UK and France as well.
But then we get to the issue of do we believe GDP numbers from China? Also increasingly anywhere.Oh what a tangled web….
Shaun, thank you for your reply. Yes, there are definitely serious problems in measuring GDP, so we should be humble in making our rankings of different countries. I wouldn’t bet the ranch that China actually overtook the US as the number one economy in 2014 rather than in 2015 or 2016. However, the gap shown in the 2021 IMF projection is crushing, and it can hardly be dismissed as due to data problems. Second, to the extent that there are data problems in measuring GDP, they affect both the exchange-rate adjusted nominal GDP estimates and the GDP on a PPP basis estimates. There is no reason to favour the former over the latter just because GDP estimates are doubtful; in fact the GDP on a PPP basis estimates, simply because they deal with GDP at a component level, are forced to some extent to standardize GDP methodologies for the different countries. Third, the big problem with exchange-rate adjusted estimates is not that they are volatile, although that is a problem, but that they only relate to tradeable goods and not to non-tradeable goods. Services, whether rents of dwellings, haircuts or dental services, in a low wage country like China are undervalued when compared to a high wage country like the United States, because these are not tradeable goods. Russia-US comparisons suffer from the same problem. Fourth, volatility is still a considerable problem and here the advantage of GDP on a PPP basis estimates is obvious. You mention France and the UK changing places in their rankings, but in fact looking at GDP on a PPP basis, from 2010 forward, they have only changed places once, in 2014, when the UK overtook France as the larger economy. The IMF projections, for what they are worth, indicate that the UK will maintain its ascendancy through 2025. Just days after the Brexit vote the Independent declared that France had now overtaken the UK as the world’s fifth largest economy, applying the post-Brexit sterling-euro exchange rate to 2015 nominal GDP for the two countries. It’s crazy, of course, but any kind of exchange rate adjustment is dysfunctional, even in less strained circumstances. In fact there was no change in 2015 between the two countries either in their relative or their world rankings. The UK was the ninth world economy in 2014, and France was the 10th. That didn’t change in 2015 or in 2016, and it remains the case today.
Andrew Baldwin
on March 18, 2021 at 3:38 pm said:
Shaun, thank you for your reply. Yes, there are definitely serious problems in measuring GDP, so we should be humble in making our rankings of different countries. I wouldn’t bet the ranch that China actually overtook the US as the number one economy in 2014 rather than in 2015 or 2016. However, the gap shown in the 2021 IMF projection is crushing, and it can hardly be dismissed as due to data problems. Second, to the extent that there are data problems in measuring GDP, they affect both the exchange-rate adjusted nominal GDP estimates and the GDP on a PPP basis estimates. There is no reason to favour the former over the latter just because GDP estimates are doubtful; in fact the GDP on a PPP basis estimates, simply because they deal with GDP at a component level, are forced to some extent to standardize GDP methodologies for the different countries. Third, the big problem with exchange-rate adjusted estimates is not that they are volatile, although that is a problem, but that they only relate to tradeable goods and not to non-tradeable goods. Services, whether rents of dwellings, haircuts or dental services, in a low wage country like China are undervalued when compared to a high wage country like the United States, because these are not tradeable goods. Russia-US comparisons suffer from the same problem. Fourth, volatility is still a considerable problem and here the advantage of GDP on a PPP basis estimates is obvious. You mention France and the UK changing places in their rankings, but in fact looking at GDP on a PPP basis, from 2010 forward, they have only changed places once, in 2014, when the UK overtook France as the larger economy. The IMF projections, for what they are worth, indicate that the UK will maintain its ascendancy through 2025. Just days after the Brexit vote the Independent declared that France had now overtaken the UK as the world’s fifth largest economy, applying the post-Brexit sterling-euro exchange rate to 2015 nominal GDP for the two countries. It’s crazy, of course, but any kind of exchange rate adjustment is dysfunctional, even in less strained circumstances. In fact there was no change in 2015 between the two countries either in their relative or their world rankings. The UK was the ninth world economy in 2014, and France was the 10th. That didn’t change in 2015 or in 2016, and it remains the case today.