The mean expected NGDP growth path fell again last week, commensurate with an increase in the 10 year Treasury yield of a similar magnitude. This was as the S&P 500 dipped below 4000 yet again.
You know the monetary policy outlook has darkened when news of an uptick in unemployment boosts the stock market, even if only ephemerally, upon the news release. Markets hope groans of pain will inspire mercy from the Fed, as it continues to try to beat down inflation expectations, collateral damage notwithstanding.
How asymmetric is the Fed’s inflation target, when they’re dissatisfied with 5 year inflation expectations that have not been above about 2.30% since late June, in PCE terms? Just when markets think they’ve figured out the Fed’s stance, they’re punished for their optimism.
While it would be silly to paint the Fed as sadistic, they are nonetheless doing harm. At the very least, they’ve failed to be clear in their communications about their reaction function leading to unnecessary volatility. For all of the good the 2% flexible inflation target did after its adoption during the pandemic, that is in getting NGDP growth back to trend, and even above, it has nonetheless introduced a vagueness to policy. The Fed has more discretion than it had in the past, which in that sense has moved policy in the wrong direction.
The Fed needs a rule that requires policy to always be more or less on track, and NGDP level targeting is just such a rule. I fear such a policy will not be adopted soon, even if something like my model for translating stock index prices into expected NGDP growth could be used, as it would virtually eliminate Fed discretion and naturally raise the question as to whether the FOMC is even needed. I hope I’m being too cynical.
As it stands now, quite contrary to the perspective I had a few weeks ago, which was optimistic about economic growth and stock market appreciation for the rest of the year, there is now just great uncertainty. I did not think a recession was likely, but now, who knows? If the Fed really wants to push NGDP growth below trend for a time, a recession obviously becomes much more likely.
Does the Fed not believe there’s still more healing to come on the supply side? If they think the supply side will continue to recover, why be concerned about inflation expectations at the moment? On the other hand, who would read this blog if the Fed eliminated most of the volatility it causes?
Note: This post, as is the case with all my posts, should not be construed as offering investment advice. Such advice should be tailored to the individual investor by qualified professionals who, ideally, are fiduciaries.
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