Now I get it!
Janet Yellen gave a speech on March 29th to the Economic Club of New York and both financial pundits and economists were suprised, even shocked, at Janet Yellen's very dovish tone on the future path of monetary policy here in the US. Heck, it was just 3 months ago when the Fed decided the economy was not only healthy enough to raise interest rates for the first time in years, but to forecast as many as 4 more rate hikes during 2016. So what happened between then and now? Data revisons!
The Industrial Production data series is put out by the Board of Governors of the Federal Reserve System. So, it only makes sence that Janet Yellen was privy to what turned out to be the alarming data revisons (negative revisions) that were going to be released just days after her speech. Here is a graph that shows the data series before and after revisions:
Here is the same data but this is looking at the year-over-year (YOY%) percentage change:
As you can see, the recent data is significantly worse than originally estimated. We have known for months now that the manufacturing sector has been contracting but according to the rivisions, it started contracting 5 months earlier than thought and the contraction is deeper than originally thought. The problems for Janet Yellen don't stop there either.
More data out this week has drastically reduced the real-time Q1 2016 GDP estimate from the Federal Reserve Bank of Atlanta. As you can see below, heading into the new year, estimates were running almost double the Q4 GDP growth rate of just 1.39%. But since peaking in February, through today, the estimate is now barely positive, coming in at just .40%.
There you have it. It is now
clear why Janet Yellen was so cautious in her speech. I expect a slight recovery in Q2 data but I was never in the 4 rate hike camp. I did expect 2 rate hikes in total but it is getting harder and harder to justify any further tightening from the Fed this year.
04/05/2016 12:03:49 PM
The Fed Dilemma: One Major Tool, Two Diverging Economies
The US economy has a problem, which means the Fed has a problem, which means bankers have a problem. It is now undeniable that the manufacturing sector is contracting (in a recession). This is visible in the chart below depicting the YOY% change in industrial production.
However, at this point, the sectors responsible for the production slump are mainly tied to the oil patch. The slump is not wide-spread enough to impact the entire US economy. The manufacturing sector today is roughly 12% of the US economy while the service sector makes up roughly 80%. This means a good portion of the economy is still healthy and growing. A good visual of this is the ISM data for the two sectors. The graph below depicts the two separate series and the two series combined into one, weighted by their economic impact.
Based on this fact alone, It is hard to conclude that the entire US economy is in a recession. However, the sharp drop in the combined index above is worrisome and must be watched closely for signs of contraction. Confirming the split in economic performance, my short-term market-based economic model is recessionary while most of my monthly models and longer leading models remain positive. Trend pressure remains decisively negative so this short-term trend could begin to eventually bleed into the monthly models. I think the market-based model serves as a warning to the Fed that the rate hike cycle must end or it will eventually lead to a US recession down the line.
This poses a challenge for bankers as it relates to managing interest rate risk: which direction, rates up or rates down, is the interest rate risk? The Fed has the data to justify more rate hikes given that wage pressures are rising and we are at "full employment". The
Fed could also just as easily heed the markets warnings and stop hiking rates in order to avoid a US recession in the future. If the Fed does stop now, with the Fed Funds Rate still near zero
the US slides into a recession, this could bring on the specture of NIRP
(negative interest rates)
as a policy tool to the US. The Fed will find itself with limited productive policy tools to fight off a recession therefor we must watch these developments closely. Even though NIRP is an extreme outlier risk at this point in the US, it is prudent for your ALCO to at least discuss it. This should prompt you to develope a contingency plan to be able to earn money under a NIRP scenario. The good news in all of this is that the banking cycle tends to run approximately 4 quarters behind the business cycle so loan demand should continue for a while yet. Thus, for bankers everywhere, the current bout of economic weakness serves a strong credit warning on any future underwriting.
03/07/2016 02:16:51 PM