Must-read: Tim Duy: “June Fades Away”
Must-Read: As I have said, what I am hearing sounds more and more like a Federal Reserve that is not engaged in a technocratic optimal-control exercise, but is instead employing motivated reasoning to find an excuse to raise rates on the grounds that an economy with unemployment at the NAIRU has normalized, and a normalized economy should have normal interest rates.
As I have said, I think this is a substantial mistake–not least because the Fed needs a higher inflation rate to give it more sea room for when the next macroeconomic storm arrives:
: June Fades Away: “At the beginning of last week, monetary policymakers were trying to keep the dream of June alive…
…Later in the week, however, financial market participants took one look at the employment report and concluded the Fed was all bark and no bite. Markets see virtually no possibility of a Fed rate hike in June. That–a desire to keep June in play coupled with insufficient data to actually make June happen–all happened faster than I anticipated. But don’t think the Fed will go down without a fight. New York Federal Reserve President William Dudley played down the April employment numbers…. Note that unemployment is settling into a level slightly above the Fed’s estimate of the natural rate of unemployment:
For Yellen, this should be something of a red flag. The plan was to let the economy run hot enough that unemployment sank somewhat below the natural rate, thereby more aggressively reducing underemployment…. [But] the labor participation rate rose… reveal[ing] that there is substantial excess capacity in the labor market, and consequently the Fed should not be in a rush to raise rates. Indeed, because they have underestimated the slack in the economy, they need to let the economy run hot for even longer….
Bottom Line: The Fed breathed a sigh of relief after financial markets stabilized. That opened up the possibility that June would still be on the table, leaving them the option for three rate hikes this year. I don’t think that policymakers will abandon June as easily as financial market participants. My sense is that they will remain coy, implying odds closer to 50-50. But the data are not in their favor…