The William Dudley Speaks...Still Waiting For Inflation

I might be the last generation of people that remembers EF Hutton. It was a middle-of-the-pack brokerage that got bought out as the industry consolidated in the late 80s. They had these ads that had the catchy tagline, “When EF Hutton speaks, people listen.”


Today, when the William Dudley speaks, people listen. Let’s go straight to today’s AP interview with the man himself and drop the money quotes:


“My outlook for the economy hasn't changed materially since the beginning of the year. Continue to look for growths around 2%, slightly above trend, growth sufficient to continue to tighten the labor market.”


Steady as she goes, then?


“If (economic growth) evolves in line with my expectations, I would expect -- I would be in favor of doing another rate hike later this year.”


Fair enough...not backing off...we hear you, Bill. But really, why do you still want to hike?


Now the reason why I think you'd want to continue to gradually remove monetary policy accommodation, even with inflation somewhat below target, is that 1) monetary policy is still accommodative, so the level of short-term rates is pretty low, and 2) and this is probably even more important, financial conditions have been easing rather than tightening.
Stocks are hot...right.
There are long lags between getting to a tight labor market and that actually showing up in higher wages, and those wages then pushing into inflation.
Ok, here’s where it gets interesting...despite unemployment at or below their estimate of full employment (or NAIRU, if you will), we’re still waiting for that “lag” to stop crushing inflation readings.
What we have to do, though, to discern is, what we see on inflation, is this temporary or is this something that's going to be more persistent?  I think the jury is out on that.
Can you give us a “best-by” date on that jury? That leaves this….which may be one of my favorite central banker quotes of the year:
“The reason why inflation won't get up to 2% very quickly on a year-over-year basis is because we've had these very low inflation readings over the last 4 or 5 months. So it's going to take time for those to sort of drop out of the year-over-year calculation.”


To summarize:
  1. Growth, still good
  2. Labor market, still tight
  3. Inflation, still invisible. But just you wait until the low numbers roll out of the index. Bill...I know some Argentines that can take care of that for you. Call me.


But I think if you look at inflation sequentially, in other words what's inflation likely to actually do over the next 6 months, I'm expecting somewhat higher readings than what we've had over the last 6 months.”
Rookie question...how has your inflation forecasting performed over the last five years?  
In fairness to Bill and the Fed, inflation forecasting is a mug’s game. Let’s take a look at a few charts that might shed light on what he’s thinking.


This is the “inflation dashboard” at the Atlanta Fed. I’m not sure how often labor costs have been at the 99th percentile while expectations have been in the 20s, but it must be pretty rare.
Let’s drill down into labor costs:




Creeping higher--I’ll agree with Bill, the jury is still out here. Could settle in at the top of the band.
More people are getting raises. Although I wager this is more typical, and the past several years have been anomalous. Again, supportive. I’ll save space and dispense with the unemployment and first-time claims chart...you know what they look like.


So Dudley is right--the labor market is showing signs of tightness beyond simply the unemployment rate. But what about prices?

Both headline and trimmed mean PCE are trending downwards. No signs of trouble here.
The broader CPI trimmed mean index looks even more encouraging for the dovish camp.

And his points on asset prices being in line with the state of the economy? Well, credit expansion doesn’t argue there is anything amiss. Again, consistent with the “steady as she goes” approach to monetary policy.


Same for capacity utilization--some room to run on the runway here.


With inflation expectations crawling back into their grave, the market has clearly cast its lot with the dovish camp.


In all...I hate to say it...but the evidence ties out to much of what Dudley says. He glossed over the *actual* inflation data way too easily--something the TIPs market clearly picked up on--and there isn’t much to suggest that is going to change anytime soon….other than labor costs. So we’re back in the cycle of watching the data for the next clue on monetary policy.


Only now do I think the market has it about right on the odds for a December hike at something like 30%....that is about how we have been conditioned to fade Fed governor pronouncements.


Regarding the broader point on risk appetite, and financial conditions--carry on!! All there is here is a tepid endorsement of what we knew already--yet high-frequency data is showing some signs of weakness. Let the party go on…

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August 15, 2017 at 1:07 PM ×

"Only now do I think the market has it about right on the odds for a December hike at something like 30%....that is about what we have been conditioned to fade Fed governor pronouncements. "

That's it for me. I've had it with these blogs guessing what is going on with the subject of rates in the Fed boardroom. Listen carefully, punters. The day that William Dudley flew over to the New York Fed boardroom meeting from the Atlanta Fed boardroom to get into the action of sizing up how much the Wall Street punters were willing to accommodate an increase in rates based on inflation data that would have any serious punter with an outlook further than a two mile horse race discard before the next Sunday's Fox game of the day. No, this rates market and the posturing from the boardroom players is an acknowledgement that the interest rates that affect the housing market and domestic currency is a LOSS LEADER and they know it.Goodbye.

https://www.google.com.au/search?q=LOSS+LEADER&oq=LOSS+LEADER&aqs=chrome..69i57&sourceid=chrome&ie=UTF-8

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Shawn
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August 15, 2017 at 2:36 PM ×

Did I really mangle a sentence like that? I'll have to have a word with the editor. Thanks for pointing that out.

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Jim
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August 15, 2017 at 8:34 PM ×

CPI inflation has been ZERO last 6 months

https://twitter.com/jmanfreddi/status/897235772461506563

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IPA
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August 16, 2017 at 2:23 PM ×

Beat and raise by TGT. Looks like WMT and TGT will run with it. I'll just stay with those two and try to ride them until some new wall shows up. TGT target $66 (pun totally intended).

Almost stopped out of XRT, saved by the bell. Sticking with it too but boy, they really took them to the cleaners yesterday. AAP, DKS, COH... Phew!

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IPA
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August 16, 2017 at 8:11 PM ×

Picking up some XLE, XOP, OIH and CHK here. Way overdone...

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abee crombie
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August 16, 2017 at 8:43 PM ×

XLE does look a little over done here, though I need an upside day to really get a buy signal. Crazy that it cannot rally at all.

EZ equities bouncing but comming up to some resistance here. That along with HY/Russell is the tell, not FAANG

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IPA
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August 17, 2017 at 12:31 PM ×

@abee, I hear you. XLE is a crazy animal once it gets going. Needs to hold 62.30 and close above it on monthly. Pretty important level going back all the way to Dec 2006. Crude could have a face ripping rally like in Sep 2010 - Apr 2011 and drag all oil related assets up with it.

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IPA
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August 17, 2017 at 8:27 PM ×

KRE close below 52 opens 51.50 fight for its life. If 51.50 doesn't hold I say it craps all the way down to 46 in one monthly candle.

VIX is not up to 8/11 high yet, but SVXY is about to test the low it made on that day. Volume is perky. Brad, Chad and Thad may be pulling an all-nighter at the office.

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IPA
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August 18, 2017 at 3:57 AM ×

Sorry guys, just putting thoughts out here. The Iran nuclear deal derailment story is picking up some steam. Crude is going to have a field day in that scenario. Saudis would love it, I bet. Seriously think WTI would fly up to $60 and catch a lot of players by surprise.

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Mi Pa
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August 18, 2017 at 4:13 PM ×

Well I like your thoughts

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cowboy
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August 18, 2017 at 4:19 PM ×

Robert Mueller, fear of Gary Cohen (or other key staff) potential resignation, Iran, NK... Are we reaching a critical mass of uncertainty?

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James Jesez
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August 18, 2017 at 7:00 PM ×

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johno
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August 18, 2017 at 7:42 PM ×

Been a while since I posted. Distracted (and distractions to continue). Some thoughts in no particular order.

Tripled a small position in short bund / long US 10Y when it widened to 1.82%. Worth mentioning that re-investments and issue limits mean the >10Y part of the German curve will see more ECB buying pressure next year compared to the 5-10Y. I assume euro strength (in particular, look at the TWI back to pre-QE level) will cause the ECB to go extra slow, maybe buying at a 40b/month pace for maybe all of 2018.

Most Chinese data I look at continues to hold up. My bigger risk-on bets the past week or so have been in short USDRUB and long aluminum. I just sold some USDARS forward today for carry. Catalyst is the weekend primary, but gave it some time for the longs to clear out. We'll see. Short EURHUF seems interesting, maybe through options. There's a central bank meeting next week which will likely be dovish, but I there's an interesting story here -- a hot economy, rising inflation, FX de-leveraging that's mostly done, a very positive basic balance, a central bank that's played its best cards already to prevent currency appreciation. Reminds me a bit of the Thai Bhat. The BoT probably wishes USDTHB were 36 but it's 33.2 instead. Maybe the NBH will be a in similar spot 6 months from now with EURHUF at 290?

The dollar continues to suck. There's a liquidity-based view articulated by some (see Nordea's latest piece, freely available, or oldschoolmacro.com) that says after the debt ceiling, we'll see USD liquidity tighten and the currency bounce. Maybe. But that same view also sees the US Treasury running down its cash balances (and therefore USD injecting into the financial system) by up to 150b if the debt ceiling debate goes down to the wire. So, still hard to get bullish the dollar. I think EURUSD maybe has another push up in it. Jackson Hole probably won't be the catalyst given the Reuters article this past week. Actually, interesting to see Yellen's speech will be on "financial stability." Maybe the Fed is quietly adjusting its view to one that acknowledges its role in creating bubbles/"financial instability." That certainly argues for some balance sheet unwind, and maybe more hikes than some anticipate, though I'm not really tempted by front-end steepeners.

As always, enjoying your posts, Shawn. Thank you!



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Eddie
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August 19, 2017 at 10:01 AM ×

Some GMO stuff.

The S&P 500: Just say no.

https://www.cmgwealth.com/wp-content/uploads/2017/08/the-s-p-500-just-say-no.pdf

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checkmate
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August 20, 2017 at 10:35 AM ×

Trumps next book should be titled 'The Art of Pissing People Off'. Somewhere recently someone replied to a comment from me that Trump was backed up by some of the best minds in the world. If that was ever true at all it appears to me he as either fired them or they have opted to walk away recognising a crash and burn artist when they see one. Are there any odds on him not completing his term of office?

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August 20, 2017 at 2:27 PM ×

Checkmate,

I don't know the odds about Trump completing his office term but , it is odds on I get to choose who I punt with otherwise I just don't get out bed, and for obvious reasons. I've learned the lesson of " The Art of I Don't Give A Fuck" how many guns you have.

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August 20, 2017 at 3:17 PM ×

@checkmate

There are markets in just about everything...

http://sports.betfair.com/?tmi=28074021

Trump not completing his term currently trading at 1/1.85 = 54%

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IPA
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August 20, 2017 at 4:54 PM ×

@EO, I remember Trump's chances of NOT winning the election were high too. We all know how well that bet went.

@checkmate, Trump would never resign, impeachment would take forever, he will probably serve the term out, but I have an idea how. Speaking of pissing people off.... Here is a thought. Bannon is going to piss Trump off by taking shots publicly at Ivanka. It will energize and turn Trump against the alt-right. Let's remember, Tump is neither right or left, he is just Trump. So, with him no longer having the platform he ran (and won the election) on behind him, and realizing his chances of re-election on that platform are zero, he may go on and complete the term as an independent, which may just be the best thing that could happen to him.

I don't want to pretend to even remotely like the guy. But here, we are traders first and political observers second. If Trump moves the markets we have to listen. No need to fight him. Let's see if what I said transpires, and if it does, there may just be a Dow 25K hat made before it's all over, and you know I am not an equity bull at these bloated levels.

Another thought of mine is that it's not Dow but DXY that is the real gauge of his presidency. If that's the case, should his independent views take off (all of a sudden) and improve US economy somehow it would boost USD a lot, imho. This seems like an likely scenario after this week's CEO defections and the toll it may take on the biz confidence/sentiment and consequently the economy. But Trump winning the election was just as unlikely, and look at where we are with that.

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