Powell reflected on situation in the 1970’s last week and then concluded that he didn’t see either “the stag” or the “flation” in today’s landscape. But the Fed’s current approach, keeping rates on hold even while inflation remains above target, is reminiscent of the opportunistic disinflation strategy of the 1990’s. This was described by Orphanides and Wilcox in their 1997 paper. They suggested that once inflation has moderated below a threshold the fed should guard against reinflation but avoid putting more pressure on real economic activity. In the 90’s this threshold was between 3% and 4%.
In the 90’s strong productivity growth and the inclusion of China in the WTO helped assuage inflation. The current situation is more difficult, with productivity gains from AI being a way off while China is still facing restrictions. Hence inflation should prove stubborn, leaving rates elevated and the Fed stuck on hold.
Reflecting this on Monday NY Fed President Williams said that the Fed needs more evidence that data is moving in the right direction, looking at the “totality of the data”. Richmond Fed President Barkin said that only “time will tell” if rates are restrictive enough at present, although he remains hopeful that they currently are. Tuesday’s rhetoric came from Fed’s Kashkari who said
there remains uncertainty around how restrictive the policy setting is and said rates will remain higher for longer than expected.
In the UK there has been a subtle change in rhetoric. Deputy Governor Ramsden has veered towards a dovish stance, seeing domestic pressures recede. The April British Retail Consortium survey (non-food) was deflationary, while unemployment had an uptick in March. Marcus Ashworth of Bloomberg writes that BOE should tailgate the Europe rather than the Fed, as the ECB heads towards a rate cut in June.
In the markets the post-FOMC and Non-Farm Payrolls recovery continued on Tuesday with yields falling a another 3-4bps in the long-end. CTA covering and program buying was suspected as UST futures pushed higher at the open. The market subsequently retreated as the first leg of this week’s $125bn UST refunding neared. The $58bn 3y auction went without a hitch; stopping about 0.3bps through (4.605%) with solid non-dealer demand (85.1%). The focus shifted to corporate issuance which was pumping. Same as Monday we had 15 issuers, but this time totalling $21bn, taking the week’s tally to around $35bn.
What’s priced in? The market is looking at 4.90% by end of the year, implying 43bps of rate cuts.