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…

Shawn
TeamMacroMan2@gmail.com
@EMInflationista