Stocks are lower this morning as oil rises. Bonds and MBS are down.
Iran and the US exchanged strikes over the weekend, with Trump threatening Kharg Island which is Iran’s primary export hub. Hitting Kharg Island would be a major escalation and would undoubtedly move oil prices much higher.
The week ahead will be dominated by the jobs report on Friday. Aside from jobs, we will get ISM data and construction spending. Earnings season is largely over, and profits were strong, helped out by tariff refunds.
Kevin Warsh spoke at Jackson Hole on Friday. Here are his prepared remarks.
On the subject of decreasing communication from the Fed:
Transparency in communications about future policy decisions is not a virtue unto itself. Communications must be in service to the Fed’s paramount responsibility: getting monetary policy right.5
Forward guidance as a regular practice was adopted by my colleagues and me during the Global Financial Crisis.6 It was essential at the time, and we introduced it with much fanfare. But, as with other legacies of crises past, I believe that the practice has overstayed its welcome.
The Fed should be humble and never naïve. The Fed plays an essential role in the economy and the markets. And our tools are powerful. We determine the path of short-term interest rates. And market participants will always try to anticipate what we will do next. But we should not indulge a regime in which market participants are looking primarily to the Fed for their next trade.
The economic literature has long described the distorting effects: a hall-of-mirrors problem.8 If markets rely materially on the Fed’s guidance and the Fed relies on market prices, we are all more likely to be blinded to new developments . . . more likely to be caught unprepared for a turn of events . . . and more likely to commit errors in policymaking.9
The key point is that providing guidance can have the opposite of the intended effect. The Fed talks, markets move and the Fed reacts to the market move. Forward guidance was something that made sense in the aftermath of the burst residential real estate bubble when deflation was a clear risk. That is no longer the case, and the Fed is returning to normalcy.
On the economy:
For my part, today I am impressed by the overall performance of the economy, which appears to have strengthened. One indicator of strength is how well an economy holds up to shocks. On that score, both Main Street and Wall Street have been remarkably resilient.
Certain sectors—like housing and agriculture—are showing strains. But, on balance, I would be hard pressed to describe broad financial conditions as restrictive.
Inflation is running above our 2 percent target. So the Fed’s predominant focus right now should be on prices. To try to gauge underlying inflation, I find it instructive to disaggregate the 199 individual components of the PCE price measure. Over the past 12 months, 54 percent of goods and services in the PCE basket showed price increases above 3 percent. This is well below the post-pandemic highs of about 77 percent, but it remains well above the level of 32 percent in the two decades that preceded the pandemic.
Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job . . . our mandate . . . and our charge to keep.
The markets interpreted his comments as hawkish and bumped up their chance of a rate hike at the September meeting. The comment that policy is not restrictive currently is sending signals that the Fed’s estimate of r-star (the neutral interest rate) is too low. You cannot estimate r-star directly, but the March projections have it at 3.1%.
If policy is not restrictive at a range of 3.5% – 3.75%, it implies we are at r-star.
Consumer sentiment remained depressed in August according to the University of Michigan Consumer Sentiment Survey. Sentiment declined 6% MOM and is down 11% on a YOY basis. Sentiment fell across groups. Year-ahead inflation expectations decreased from 4.2% to 4.0% and longer-run expectations were unchanged at 3.3%.
