Comerica Economic Weekly

U.S. data was mixed this week, consistent with our expectation of modest first quarter real GDP growth. We look for about 1.1 percent 2017Q1 real GDP growth when the data is released next Friday.

Housing starts dropped by 6.8 percent in March. The trend still looks positive and the March reset looks like normal monthly volatility. Single-family starts for March dropped by 6.2 percent for the month, but remain up by 9.3 percent over the previous 12 months. Multifamily housing starts fell by 7.9 percent for the month. Total permits for March were up by 3.6 percent.

According to the MBA Mortgage Applications Survey, the rate for a 30-year fixed rate mortgage was down to 4.22 percent for the week ending April 14. Mortgage applications for purchase were down into mid-April.

The National Association of Home Builders’ Housing Market Index fell modestly in April, still showing strong confidence in the market.

Existing home sales increased by 4.4 percent in April, after dipping in March. The median sales price of an existing home was up by 6.8 percent in March, over the previous 12 months.

Industrial production increased by 0.5 percent in March, pushed by a large increase in utility output. Mild winter weather weighed on utility output in January and February, but that reversed in March as utility output surged by 8.6 percent. Mining output ticked up by 0.1 percent in March, after a strong 2.9 percent gain February. Manufacturing output dropped by 0.4 percent as motor vehicle assemblies fell.

The Leading Economic Index increased by 0.4 percent in March, extending a string of moderate-to-strong monthly gains that began last December. This is good news for the U.S. economy and is consistent with our expectation that real GDP growth will pick up in 2017 after a tepid first quarter.

Initial claims for unemployment insurance increased by 10,000 for the week ending April 15, to hit 244,000, still a very low number. Continuing claims fell by 49,000 for the week ending April 8, dropping below the two million mark to hit 1,979,000, an exceptionally low number. The basket of solid labor market indicators suggests that the weaker-than-expected March payroll job gain of just 98,000 was more fluky than substantive.

For a PDF version of the Comerica Economic Weekly, including forecast tables and the variables calendar, click here:  Comerica_Economic_Weekly_ 04212017.

 

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March Leading Indicators, Philly Fed, April UI Claims

 Indicators Still Positive for U.S. Economy

  • The Conference Board’s Leading Economic Index for March increased by 0.4 percent.
  • Initial Claims for Unemployment Insurance gained 10,000 for the week ending April 15, to hit 244,000.

The Conference Board’s Leading Economic Index increased by 0.4 percent in March, extending a string of moderate-to-strong monthly gains that began last December. The Leading Index incorporates 10 components that provide forward-looking insight into the U.S. economy. Eight out of the 10 components were positive in April. In order of the magnitude of their positive contribution, they were interest rate spread, ISM new orders, consumer expectations for business conditions, building permits, stock prices, a credit index, manufacturers’ new orders for nondefense capital goods ex-aircraft and manufacturers’ new orders for consumer goods. The two negative contributors for the month were weekly manufacturing hours and initial unemployment insurance claims. The string of positive reports for the LEI is good news for the U.S. economy and is consistent with our expectation that real GDP growth will pick up in 2017 after a tepid first quarter. Much depends on the ability of the Trump Administration to push its pro-growth agenda through Congress. Several LEI components are responsive to the political climate, including consumers’ expectations and stock prices. Stock prices slumped through the second half of March and through April, and that could weigh on the LEI next month. Related to the LEI are the Coincident Economic Index (CEI) and the Lagging Economic Index (LAG). The CEI registered a modest 0.2 percent gain in March, reflecting the slow first quarter, while LAG was unchanged for the month. It is considered to be a meaningful recessionary indicator when all three indexes go negative at the same time. We are very far away from that.

Initial claims for unemployment insurance increased by 10,000 for the week ending April 15, to hit 244,000, still a very low number. Continuing claims fell by 49,000 for the week ending April 8, dropping below the two million mark to hit 1,979,000, an exceptionally low number. The basket of solid labor market indicators suggests that the weaker-than-expected March payroll job gain of just 98,000 was more fluky than substantive.

The Federal Reserve Bank of Philadelphia’s Manufacturing Business Outlook Survey’s current conditions index dipped to a still-positive 22.0, suggesting that manufacturing conditions in the mid-Atlantic area are still improving, but at a slower pace than last month.

Market Reaction: Equity markets opened with gains. The 10-Year Treasury bond yield is up to 2.24 percent. NYMEX crude oil is down to $50.28/barrel. Natural gas futures are down to $3.24/mmbtu.

For a PDF version of this Comerica Economic Alert click here: Leading_Indicators_04202017.

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March Residential Construction, Industrial Production

Starts Rebalance After February Bump

  • Housing Starts decreased in March by 6.8 percent to a 1,215,000 unit annual rate.
  • Permits for new residential construction increased by 3.6 percent to a 1,260,000 unit pace in March.
  • Industrial Production increased by 0.5 percent in March, pushed by utility output.

After a 5.0 percent increase in February, total U.S. housing starts dropped by 6.8 percent in March. The trend for total starts still looks positive and the March reset looks like normal monthly volatility. Single-family starts for March dropped by 6.2 percent for the month, but remain up by 9.3 percent over the previous 12 months. Multifamily housing starts fell by 7.9 percent for the month, and remain below the level from last December. Today’s housing data reinforces our belief that multifamily construction will be range bound for much of this year as absorption in local markets eases with strong recent supply additions. Conversely, we look for more gains on the single-family side, supported by more economically confident millennials growing their families. The inventory of available new and existing homes for sale remains historically tight and this will keep builders building single-family houses. However, many builders report a shortage of construction labor which is hampering completion rates. Total permits for March were up by 3.6 percent. Permits for new single-family projects eased by 1.1 percent, while multifamily permits gained 13.8 percent, which is not a huge number given the normal monthly volatility. Mortgage rates have eased after the March 15 fed funds rate hike. According to the MBA Mortgage Applications Survey, the rate for a 30-year fixed rate mortgage was down to 4.28 percent for the week ending April 7. Mortgage applications for purchase were positive in early April, a good sign for the spring home buying season.

Total industrial production increased by 0.5 percent in March, pushed by a large increase in utility output. Mild winter weather weighed on utility output in January and February, but that reversed in March as utility output surged by 8.6 percent. Mining output ticked up by 0.1 percent in March, after a strong 2.9 percent gain February. Even though many other manufacturing indicators were positive in March, the Federal Reserve’s report shows a 0.4 percent drop in manufacturing output, consistent with a 3.8 percent drop in motor vehicle assemblies for the month. The March decline in auto sales, to a 16.6 million unit rate, invites speculation about the shape of the auto sales curve through this year and next. We believe that there is growing potential for a flattish top to the auto sales cycle for a number of reasons. First, consumer confidence has surged since the general election last fall. Second, labor conditions remain very tight with the unemployment rate down to 4.5 percent. Third, the age of the vehicle stock remains high and vehicles that were purchased in the early months of the economic recovery, in late 2009 and 2010, are at replacement age. Fourth, the share of household income going to auto sales is still low, down from 5-6 percent of total consumer spending in the early 2000s, to 3.8 percent in 2016Q4.

Market Reaction: Stock indexes opened with losses. The yield on 10-Year Treasury bonds is down to 2.20 percent. NYMEX crude oil is down to $52.63/barrel. Natural gas futures are down to $3.24/mmbtu.

For a PDF version of this Comerica Economic Alert click here: Housing_Starts_041817.

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Reshaping the Trump Bump and the Monetary Offset

The policy machinations of Washington D.C. will figure very large in the U.S. economy over the next year, both in terms of Trump Administration fiscal policy and the Yellen Fed monetary policy. Nearing the end of its first hundred days, the Trump Administration has fostered a business-friendly environment through the rollback of regulations via executive order. U.S. equity prices responded favorably to the initial steps and overall expectations of the potential Trump Bump on the economy were high. However, the Trump Administration’s first legislative challenge, the rollback of the Affordable Care Act, was successfully thwarted by an unlikely coalition of Democrats and conservative Republicans. Because of the potential tax and deficit implications of the American Health Care Act, it was interlinked with the tax reform and spending initiatives that were to follow. The failure of the American Health Care Act 1.0 to clear the House, much less the tougher hurdle in the Senate, increased doubts about the scope and the success of tax reform and infrastructure programs. Last week, President Trump renewed his public discussion of tax reform and a $1 trillion infrastructure program at the CEO Town Hall. These programs are potential game changers for the U.S. economy. If the Trump Administration can clear the runway with the passage of the American Health Care Act 2.0, and/or achieve a reasonable portion of the tax reform and $1 trillion infrastructure spending packages, then the Trump Bump will give us a significant lift in 2018. We have flattened our near-term GDP forecast and pushed the Trump Bump back into 2018 with the expectation that the Trump Administration will have a least some success with tax reform and infrastructure spending.

This spring has also been an interesting time at the Federal Reserve. New York Fed President Bill Dudley’s Bloomberg interview and the follow-up article in the Wall Street Journal on March 31 gave the public the first glimpse of the Fed’s still-evolving plan for balance sheet reduction. More discussion was released to the public in the minutes of the March 14/15 Federal Open Market Committee meeting. According to the FOMC minutes, the Fed is focusing on a passive reduction in their $4.5 trillion balance sheet by ending the reinvestment of maturing assets, beginning later this year. The ending or phasing strategy could be different for different types of securities. The timing of the change in reinvestment policy could depend on economic and financial market conditions. Also, reinvestment could be restarted if the economy encountered significant adverse shocks. It was noted in the minutes that the FOMC would continue to discuss balance sheet policy during upcoming meetings. One possible strategy for the Fed would be to raise the fed funds rate range two more times this year, once on June 14, and then again on September 20, and then keep interest rates unchanged through the end of this year as the Fed initiates balance sheet roll-off.

Most U.S. and international economic data continues to be healthy. However, despite other strong labor data, the official payroll job count for March showed a weaker-than-expected gain of 98,000 jobs. The separate household survey of employment, which feeds into the unemployment rate calculation, posted an outsized gain of 472,000 jobs, bringing the unemployment rate down to a tight 4.5 percent, the lowest since May 2007. The Fed will see two more monthly jobs reports before the June 13/14 FOMC meeting, when we expect them to next raise the fed funds rate.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: US_Economic_Outlook_0417.

 

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Comerica Economic Weekly

It has been an active week for economic developments. U.S. economic data was generally positive this week, despite the miss on March payroll employment. We saw some discussion in the minutes of the March Federal Open Market Committee meeting that suggests that they will begin to roll-off maturing assets before the end of this year. On Thursday evening, the United States launched a Tomahawk missile attack on an airbase in Syria, resulting in a small upward movement in crude oil futures. Syria is not a major oil producer and its production capacity has deteriorated significantly in recent years. However, Syria’s proximity to other major oil producers and oil distribution routes adds some uncertainty to future oil prices. There are reports of a possible terrorist incident in Sweden this morning.

Despite the strong ADP jobs report for March, released on Wednesday, the official Bureau of Labor Statistics jobs report for March showed a much weaker-than-expected 98,000 net new payroll jobs. In contrast to the weak payroll survey, the household survey of employment recorded another very strong month, surging by 472,000 jobs after a similar 447,000 job gain in February. The household employment numbers feed into the unemployment rate, and brought it down more than expected, to a tight 4.5 percent.

We expect to see a stronger jobs report for April, to be released on May 5, after the upcoming FOMC meeting over May 2 and 3.  The weak March payroll data will not, by itself, change Federal Reserve monetary strategy. The Fed will see two more jobs reports before the June 13 and 14 FOMC meeting. We expect the Fed to leave interest rates unchanged on May 3 and then to increase the fed funds rate range by 25 basis points on June 14. The implied odds of a fed funds rate hike on June 14 are about 63 percent, according to the fed funds futures market.

The ISM Non-Manufacturing Index fell from 57.6 in February, to a still-positive 55.2 in March. The ISM Manufacturing Index for March eased to a still-positive 57.2 in March, indicating ongoing improvement in the nation’s manufacturing sector. Together, the two ISM reports suggest that the rate of overall business activity remained positive, but eased at the end of Q1.

Construction spending for February gained 0.8 percent, boosted by private multi-family projects.

Vehicle sales for March stepped down to a 16.7 million unit annual rate, after hitting a 17.6 million unit rate in February. Bad weather was a possible factor, but the step down in March vehicle sales is consistent with widely held expectations of lower auto sales this year, after last year’s record rate. Several factors suggest that there could be a flat top to the auto sales cycle, rather than a steep peak, following by a valley. First, the unemployment rate, at 4.5 percent is very low. Conversely, consumer confidence is up. The percent of household income spent on autos is low, suggesting that there is upside potential and the average age of the auto fleet remains high.

Applications for home mortgages for purchase increased through the second half of March, while applications for refinance fell. According to the Mortgage Bankers Association, rates for 30-year fixed-rate mortgages eased through the second half of March.

U.S. crude oil inventories increased through the second half of March, putting downward pressure on prices. However, increased tensions in the Middle East will add a risk premium to prices, likely offsetting the effect of the U.S. inventory gain.

For a PDF version of the Comerica Economic Weekly, including forecast tables and the variables calendar, click here: Comerica_Economic_Weekly_ 04072017.

 

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March U.S. Employment

Quirky Report Shows Weaker-than-Expected Payroll Gain Despite Other Strong Indicators

  • Payroll Employment increased by only 98,000 jobs in March. The household survey surged by 472,000 jobs.
  • The Unemployment Rate for March fell to 4.5 percent.
  • Average Hourly Earnings increased by 0.2 percent for the month, the average workweek was unchanged.

Despite the strong ADP jobs report for March, released on Wednesday, the official Bureau of Labor Statistics jobs report for March showed a much weaker-than-expected 98,000 net new payroll jobs. In contrast to the weak payroll survey, the household survey of employment recorded another very strong month, surging by 472,000 jobs after a similar 447,000 job gain in February. The household employment numbers feed into the unemployment rate, and brought it down more than expected, to a tight 4.5 percent. Retail trade employment was a big drag on the payroll survey, declining by nearly 30,000 jobs, instead of adding the usual 20,000 or so, and that represents a 50,000 job swing in the data. This is consistent with anecdotal reports of stress on the brick-and-mortar side of retail sales. Piling on, January and February payrolls were revised down a total of 38,000 jobs. It is not unusual to have a month of weak payroll job growth following a string of strong months, and so the weak March payroll jobs numbers should not be interpreted as a sign of an imminent economic slowdown. Also, bad weather on the East Coast in March was a possible drag. We expect to see a stronger jobs report for April, to be released on May 5, after the upcoming FOMC meeting over May 2 and 3.  Today’s data will not, by itself, change Federal Reserve monetary strategy. The Fed will see two more jobs reports before the June 13 and 14 FOMC meeting. We expect the Fed to leave interest rates unchanged on May 3 and then to increase the fed funds rate range by 25 basis points on June 14. The implied odds of a fed funds rate hike on June 14 are about 62 percent, according to the fed funds futures market.

The climbing rig count motivated hiring in the mining and logging sector, which added 11,000 net new jobs in March. Construction was weaker than expected, adding 6,000 jobs for the month, possibly held down by bad weather on the East Coast. Manufacturing was solid, adding 11,000 net new jobs, consistent with the positive employment sub-index of the March ISM-MF report. Wholesale trade dropped just 400 jobs, but retail trade was a big drag, shedding 29,700 jobs for the month. Transportation and warehousing industries added 3,500 jobs. Information services dropped 3,000. Financial activities employment increased by 9,000 jobs. Professional and business services added a solid 56,000 jobs for the month. Education and healthcare was a little soft, gaining only 16,000 net new jobs. Likewise, leisure and hospitality industries increased their payrolls by 9,000 for the month. The government sector was a little light, adding 9,000 jobs as Federal government employment fell by 1,000, consistent with the Federal hiring freeze.

The United States’ Tomahawk missile attack on an airbase in Syria last night has resulted in a small upward movement in crude oil futures. Syria is not a major oil producer and its production capacity has deteriorated significantly in recent years. However, Syria’s proximity to other major oil producers and oil distribution routes adds some uncertainty to future oil prices.

Market Reaction: U.S. equity markets opened with losses. The 10-Year T-bond yield is down to 2.30 percent. NYMEX crude oil is up to $51.92/barrel. Natural gas futures are down to $3.28/mmbtu.

For a PDF version of this Comerica Economic Alert click here: Employment_04052017.

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March ADP Jobs, ISM Non-MF, FOMC Minutes

Ongoing Strong Job Gains and Discussion of a Shift in Fed Policy

  • The March ADP Employment Report showed another strong gain, adding 263,000 private-sector jobs.
  • The ISM Non-Manufacturing Index eased to a still-positive 55.2 in March.
  • The minutes of the FOMC meeting of March 14/15 show discussion about reducing the Fed’s balance sheet.

The ADP National Employment Report for March showed another month of strong job growth with 263,000 net new private sector jobs added to the U.S. economy. This report is an important precursor to the official Bureau of Labor Statistics jobs data for March that will be released at 7:30 Central Time Friday morning. The strong ADP report suggests that we will see a similarly strong BLS jobs number for March. The two reports do not have to follow in lock step, because they are derived from completely different methodologies, but over time ADP and the BLS tend to be well correlated. However, since last November ADP private sector job growth has tended to over-estimate BLS private non-farm job growth. Normally we would add about 10,000 jobs to the ADP private-sector total to get an estimate for the BLS non-farm payrolls. However, given the federal government hiring freeze, we will assume that government hiring will not add significantly to the private-sector total. Also, to be conservative, we will shave a little off the ADP number and go with an estimate of about 210,000 net nonfarm jobs added in March, leaving the unemployment rate unchanged at 4.7 percent.

The Institute of Supply Management’s Non-Manufacturing Index fell from 57.6 in February, to a still-positive 55.2 in March. This means that the broad service sector is still improving in March, but not as quickly as it did in February. Nine out of ten sub-indexes were in positive territory. Only inventories contracted for the month. The ISM’s Non-Manufacturing Index stepped down in March after a strong February, and so did their Manufacturing Index. Together these reports suggest that the rate of overall business activity remained positive, but eased through end of the first quarter.

In the minutes of the March 14/15 Federal Open Market Committee meeting, we see the discussion of plans to reduce the size of the Fed’s expanded balance sheet. The discussion focused on a passive reduction in the balance sheet by ending the reinvestment of maturing asset rather than an active strategy of direct sales of assets. Reinvestments could be ended at once, or they could be phased out. The ending or phasing strategy could be different for different types of securities, but it should result in a gradual and predictable reduction in the Fed’s security holdings. The timing of the change in reinvestment policy should depend on economic and financial market conditions. Reinvestment could be restarted if the economy encountered significant adverse shocks. The policy should be communicated to the public well in advance. Also, it was noted that the FOMC would continue to discuss balance sheet policy during upcoming meetings. The next FOMC meeting will be over May 2/3. We believe that the Fed will allow the passive roll-off of maturing assets before the end of this year. One possible strategy would be to raise the fed funds rate two more times this year, once on June 14, and then again on September 20, and then keep interest rates unchanged through the end of this year as the Fed initiates balance sheet roll-off.

Market Reaction: U.S. equity prices dipped after the release of the Fed minutes. The yield in 10-Year T-bonds is down to 2.34 percent. NYMEX crude oil is up to $51.05/barrel. Natural gas futures are down to $3.25/mmbtu.

For a PDF version of this Comerica Economic Alert click here:  ADP_04052017.

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February U.S. International Trade

Fears of Big Drag from Trade on Q1 GDP Diminished with New Data

  • The Trade Gap narrowed by $4.6 billion in February, to -$43.6 billion.
  • Exports increased marginally by $0.4 billion, with slightly stronger exports of goods.
  • Imports fell by $4.3 billion, reversing the surge in goods imports in January.

Trade has been in the news, not only because of Trump Administration initiatives, but also because of all the moving parts and their impact on U.S. GDP and debt. A widening trade gap is a drag on GDP and it requires more borrowing. Conversely, a narrowing trade gap lifts GDP and requires less borrowing. A key moving part in the trade story is the value of the dollar. A strong dollar makes our exports expensive for other countries and it makes their imports to the U.S. cheaper, and so a strong dollar tends to widen the U.S. trade gap. To see the swings in the value of the dollar most broadly, we can look at an index like the Federal Reserve’s weighted average exchange value of the dollar adjusted for inflation. It shows the inflation adjusted value of the dollar weighted against the inflation adjusted currencies of our major trading partners. Since bottoming out in July 2011, the trade weighted value of the dollar has increased by nearly 25 percent, making imports cheaper and our exports more expensive. Relative economic performance between countries, inflation rates, interest rates and the supply and demand of internationally traded financial instruments (government debt is a big component) all influence the value of the dollar and, in turn, influence the trade gap. Global supply and demand for specific goods also influence the trade gap. The U.S. is increasing exports of crude oil and other energy products as the “shale gale” unleashes significant supplies. This will help to narrow the trade gap and support U.S. GDP.

In the February trade data we see a major $4.6 billion narrowing of the trade gap after it widened significantly in January. The narrowing came primarily from a reduction in imports, driven by consumer goods (cell phones and other goods) and by automotive vehicles and parts. The trade balance of goods tends to be more volatile than the trade balance of services, and goods are tracked more closely than services. So we can see that the average inflation adjusted trade balance in goods for January and February is about even with the average for the fourth quarter of 2016. In plain English, the bounce back in the trade data for February cancels out the fear of a big drag from trade in 2017Q1 GDP. We could still have a surprise for March that would shift the first quarter average, but that appears to have a low probability.

Market Reaction: U.S. equity markets are mixed. The yield on 10-Year Treasury bonds is up to 2.35 percent. NYMEX crude oil is up to $51.13/barrel. Natural gas futures are up to $3.26/mmbtu.

For a PDF version of this Comerica Economic Alert click here:  International_Trade_04042017.

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March ISM-MF Index, February Construction Spending, Fed Balance Sheet

 Good Data Accompanies Discussion of Fed’s Balance Sheet

  • The ISM Manufacturing Index for March decreased to a still-positive 57.2, showing improving conditions.
  • Construction spending increased by 0.8 percent in March, boosted by private multi-family projects.

The ISM Manufacturing Index for March eased to a still-positive 57.2 in March, indicating ongoing improvement in the nation’s manufacturing sector. The new orders sub-index shows vigorous activity, easing slightly to 64.5. The production sub-index backed off a strong February reading, to a solid 57.6 in March. The employment sub-index increased to 58.9, good news for the March employment report, due out this Friday. There is some concern that March job gains might be soft, resetting from recent better-than-expected gains. However, the ISM report indicates that manufacturing hiring may remain engaged this spring, even after the robust 28,000 net job gain in the Bureau of Labor Statistics data for February. Of the 18 reporting industries in the ISM report, 17 expanded in March. The strongest growth was in electrical equipment, appliances and printing. Anecdotal comments were positive. One comment noted that “material inflation is now clearly upon us.” This sentiment was mirrored in the commodity price portion of the report, where 23 tracked commodities were up in price and none were down.

Construction spending for February increased by 0.8 percent. Private residential construction spending increased by 1.8 percent for the month, boosted by multi-family projects. Spending on private non-residential projects eased by 0.3 percent, with six out of 11 categories down for the month. Total public construction spending increased by 0.6 percent in February despite a dip in power-related projects.

Also noteworthy from Friday, the Wall Street Journal reported at the end of the day that the Federal Reserve is readying plans for balance sheet reduction. The article reports that under the emerging strategy, the Fed would increase short-term interest rates two more times this year, and then pause later in the year. During the pause in the interest rate cycle, the Fed would start winding down their portfolio “in a gradual and measured way.” This back-and-forth monetary strategy is justified, according to the article, by normalizing inflation metrics. We assume that the first phase of balance sheet run-off would be to stop reinvesting maturing assets. The drop in demand for bonds could result in lower prices, pushing up bond yields. The minutes of the March 14-15 Federal Open Market Committee meeting are due out this Wednesday, April 5. We expect to see additional discussion of balance sheet operations in the Fed minutes.

Market Reaction: U.S. equity markets opened with losses. The yield on 10-Year Treasury bonds is down to 2.33 percent. NYMEX crude oil is down to $50.16/barrel. Natural gas futures down to $3.14/mmbtu.

For a PDF version of this Comerica Economic Alert click here:  ISM-MF_04032017.

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From the Desk of Robert Dye

Tactical Versus Strategic Thinking at the Fed

Last Monday I wrote that the Fed still has work to do in order to set monetary policy expectations for the second half of this year. This week, various Fed officials, including FOMC Chairwoman Janet Yellen, Vice-Chairman Stanley Fischer, and regional Fed presidents Williams, Evans, Rosengren, Dudley and Bullard all made comments that at least touched on expectations for monetary policy for the remainder of this year. Their comments collectively suggest that there is an active debate within the Fed about what to do in the second half of 2017. I have argued that the Fed is close to setting an expectation for a 25 basis point rate hike at every other FOMC meeting, beginning with the December 14, 2016 rate hike. Moreover, the pattern of rate hikes would coincide with FOMC meetings that include scheduled press conferences. If they skip May 3 and hike again on June 14, as implied by the fed funds futures market, they will be on that every-other-meeting cadence. If they stick to the three rates hikes, as implied by the March 15 “dot plot,” after hiking in June, then they will have to change the cadence of rate hikes in the second half of this year.

Most of this week’s Fed commentary indicated some comfort with three rate hikes for 2017 as implied by the December 14 “dot plot.” However, there was plenty of wiggle room for more or less than two more rate hikes this year, implying a feasible range of 2 to 4 rate hikes this year.  This suggests that the Fed collectively is watching the Trump Administration very closely, in order to gauge how the economy is reacting and will react in the future to the successes and failures of the Trump policy initiatives. I think they are watching oil prices too. The recent volatility in oil prices is having an effect on inflation indicators.

In this environment, the Yellen Fed will have to remain somewhat tactical, responding to current conditions and near-term expectations, rather than driving toward the strategic goal of policy normalization regardless of near-term economic and political volatility. A tactical Fed is all about communication. Failure to communicate and set appropriate expectations for financial markets could lead to financial dislocations, with possible adverse feedback, reminiscent of former chairman Bernanke’s Taper Tantrum. This suggests that the Fed itself could add to volatility in the months ahead if they take a tactical zig, when financial markets expect them to zag. Conversely, focusing on the strategic goal of renormalizing monetary policy, while not responding to near-term issues, also poses risks if the Fed would slavishly move toward a policy goal regardless of near-term volatility. As she considers what is likely her last year at the helm of the Fed, Janet Yellen still has challenges in front of her.

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