What We Learned Last Week
- Fed issues dominated last week’s market conversations:
- As the Fed prepares to lift its federal funds rate target from 0 to 0.25 percent, with the idea eventually of returning the funds rate to a more normal 3 to 4 percent level (1 to 2 percentage points above the 2 percent inflation target), the conversation is shifting to the pace of increases. If inflation remains too low and only slowly returns to the 2 percent long-run target, as the Federal Open Market Committee (FOMC) anticipates, the pace of rate increases will be gradual. If it climbs more quickly, the Fed likely will move more quickly.
- One argument bolstering the case for gradualism is an assumption that the equilibrium level of interest rates, where the Fed aims to go, has fallen as a result of the deceleration in potential growth. Staff analysis reported in FOMC minutes released last week indicated that at present the equilibrium real rate of interest may be close to zero (implying the nominal equilibrium federal funds rate may be around 1.5 percent). Where the Fed is headed depends, of course, on judgments about the equilibrium rate consistent with a fully-employed economy and 2 percent inflation—conditions that meet the Fed’s dual mandate—and not the current rate.
- Assessments of the Fed policy outlook are more complicated than usual because economic metrics are influenced more than usual by cyclical and structural factors and because monetary stimulus is provided by the federal funds rate actions as well as asset purchases—unconventional monetary policy—that have held down long-term real interest rates close to zero.
- Industrial activity was firm in October beyond Mother Nature’s impact and the ongoing cutbacks related to reduced activity in the shale petroleum formations.
- Housing starts are volatile month to month, largely owing to choppiness in the booming multi-family sector, but the underlying trend is improving steadily.
- The core Consumer Price Index (CPI) inflation rate is close to the Fed’s 2 percent long-run goal, but this inflation metric is outdated because it covers only a small segment of the health care industry. The more comprehensive core Personal Consumption Expenditure (PCE) inflation rate—what guides the Fed—is about 1.25 percent. The gap between the CPI and PCE inflation rate continues to widen. Overall inflation is zero in 2015, thanks to energy price declines.
- Jobless claims eased back into the full-speed-ahead zone.
What We Expect to See in the Week Ahead
- The initial 3Q real Gross Domestic Product (GDP) growth estimate of 1.5 percent annualized is expected to be pushed up to 2.3 percent.
- The broadest measure of consumer spending in October is expected to be solid, with outlays for services, what are not included in the monthly retail sales reports, trending strong.
- Forecasts call for moderate gains in durable goods but solid headline gains from a pickup in orders for aircraft.