Monday, July 1, 2013

More "Fed-speak"

Various US Federal Reserve officials have been making speeches in the last few days in an attempt to calm market jitters following the June FOMC meeting and the markets expectation of an imminent end to the Feds asset purchase program.

The Dallas Fed President Richard Fisher went so far as to label market participants, who have pushed bond yields sharply higher, as “feral hogs”.  I vastly prefer former NZ Prime Minister David Lange’s kinder, gentler reference to “reef fish”.  Other speeches from the likes of Bill Dudley (New York Fed) and Dennis Lockhart (Atlanta Fed) were tamer by comparison but made highly pertinent points.

In particular from Dudley: “If labor market conditions and the economy’s growth momentum were to be less favourable than in the FOMC’s outlook – and this is what has happened in recent years – I would expect that the asset purchases would continue at a higher rate for longer”.

The fact of the matter is it’s by no means certain the Fed will start to reduce the pace of its asset purchase program soon.  As I said following the FOMC meeting the hurdle to tapering is high.  While we agree with the Fed that US growth will be higher in the second half of this year, our forecasts aren’t as high as theirs.  Furthermore, while we think employment growth continues, we were intrigued by the blip higher in the participation rate in May which contributed to a RISE in the unemployment rate.  Friday’s June labour market report will be fascinating.  And perhaps most importantly, there is no sign yet that the recent drop in inflation is indeed due to “transitory influences”.  The annual rate of PCE inflation was unchanged at 1.1% in May.

What we have seen in the last few days is interest rate markets anticipating the end of QE.  While it’s reasonable for markets to anticipate events, we agree with the argument that markets have got somewhat ahead of themselves.

On the other hand, I like the fact that the move higher in interest rates is reflected in higher real yields.  That means that rather than an igniting of inflation fears, we are seeing a normalisation of expectations for monetary policy and with that, economic growth.  In that respect interest rates are actually rising for the right reasons.