The Foul Is Fair Market
“Fair is foul and foul is fair” sounds like a Shakespearean version of “good news is bad news.”
For months now, financial markets have reacted to good news—consumer spending rises! more jobs than expected! wages going up!—as if they were poisoned darts. The reason for this is, of course, because each piece of good news is seen as pushing off the day on which the Fed may cut interest rates.
What if all the sound and fury over interest rates signify nothing?
A comical scene played out across trading desks and newsrooms in our struggling republic on Friday. With very little economic data set to pour forth from its usual fonts, the scribes and traders focused their attention on the annual revisions to the seasonal adjustments the Bureau of Economic Analysis uses to calculate the consumer price index (CPI).
For as long as anyone can remember, almost no one has paid much mind to the CPI seasonal adjustment revisions. Last year, however, the seasonal adjustments were especially large, and the revised figures showed that the trend of prices had not been as benign as it had appeared to be. Fed policy makers and the market participants who look to them were startled.
Federal Reserve Governor Christopher Waller mentioned last year’s revisions in his recent talk with David Wessel of the Brookings Institution, thus drawing even more attention to this year’s revisions, which Waller said he would be watching:
Recall that a year ago, when it looked like inflation was coming down quickly, the annual update to the seasonal factors erased those gains.
In mid-February, we will get the January CPI report and revisions for 2023, potentially changing the picture on inflation. My hope is that the revisions confirm the progress we have seen, but good policy is based on data and not hope.
Waller may be the most important Fed governor today. Federal Reserve Chairman Jerome Powell is said to have a serious respect for Waller’s economic analysis. His long tenure as the head of research at the St. Louis Fed gives his views on the economy additional weight. So, when he says he is watching something as obscure as the revisions to CPI seasonal adjustments, the data develops an unprecedented gravity.
As it turned out, the revisions revised very little. In the chart below, the red line represents the revised data and the blue line represents the pre-revision data for the monthly change in the consumer price index.
Here’s what it looks like for core CPI:
The best interpretation of this is that the revisions did indeed “confirm the progress” on inflation seen last year. There’s still room for debate on how much progress there has been in the last six months—sure looks like disinflation has stalled to us—but whatever your view was before the revisions, there is little reason to change it now.
Is No News Good News or Just No News?
“Bring me no more reports. Let them fly all,” Macbeth declares as the end of the Scottish play nears.
The Scottish usurper has become exhausted by the constant reports of desertions, defections, and the approaching enemy forces, impatient for the inevitable clash of arms. You can almost picture him hunched over in front of his terminal, weary of parsing the latest data for indications of when the Fed will cut interest rates.
The history books will likely not record whether the Fed cut interest rates in May or June. The shockwaves sent through markets by the Fed’s signal that it would not cut in March will be quickly concealed by the dust of time.
Laurence Olivier and Vivien Leigh are seen portraying the roles of Macbeth and Lady Macbeth in a 1955 production of the Shakespeare play at Stratford-on-Avon, England.
This is actually the primary reason it makes sense to expect the Fed will hold off on rate cuts. There is very little cost to delay with the economy growing at a rapid clip and unemployment increasingly just a distant memory of those sickly times a few years past. A month or three delay in rate cuts is unlikely to be the difference between a growing economy and a recession.
Shakespeare’s Macbeth, we should point out, does not last long in his abstinence from news. Just 30 or so lines later, he is asking his still-loyal servant, “What news more?” In modern times, he would be back to scrolling, checking his inbox, and hitting refresh.
There may be a larger lesson to be learned from the CPI revision episode. The CPI revisions did not turn out to matter much—just as the Federal Reserve’s rate hikes appear not to have weighed on growth very much. Which raises the question of whether interest rates matter as much as everyone seems to think.
A little over a decade ago, a pair of economists working at the Federal Reserve investigated “the sensitivity of a business’s capital expenditures to changes in interest rate.”
The economists, Steven Sharpe and Gustavo Suarez, looked at a survey conducted by Duke University and CFO Magazine of the chief financial officers of hundreds of U.S. companies. They found that CFOs believe that they are not really all that responsive to interest rates at all. Falling interest rates do not prompt more investment, and rising rates do not discourage investment much.
Their paper’s title sums it up well: “The Insensitivity of Investment to Interest Rates: Evidence from a Survey of CFOs.”
This would explain why interest rates had a much smaller effect than expected. Think of it as an alternative to the explanation (which we explored in an earlier edition of Breitbart Business Digest) that hikes mattered less because the neutral rate of interest is higher than previously thought.
When Sharpe and Suarez were doing their work, the big mystery was the opposite of today’s: why were ultra-low rates and quantitative easing not raising inflation or the growth rate very much? In other words, inflation appeared to be ineffective on the downside.
Here is what Ed Harrison, now at Bloomberg, wrote:
I think monetary policy is ineffective. We don’t even know how it works. Sure, rate policy can help at critical junctures in the business cycle by lowering interest payments when debtors are under stress. But, we’ve hit the limits of what central banks can do. As a result, we’ve resorted to quantitative easing, negative interest rates, and yield curve control. And for what? It’s crazy.
The solution is staring us in the face: help put money in the pockets of the people who are facing the most severe financial stress in our economies. Those are the people who need the money the most and are most likely to spend that money too. Until we do that, the stress on our economic and financial system will continue to grow… and political unrest will continue to grow with it.
I am going on holiday now. Maybe the beach will put [me] in a positive frame of mind.
Shakespeare put it like this:
Life’s but a walking shadow, a poor player
That struts and frets his hour upon the stage
And then is heard no more. It is a tale
Told by an idiot, full of sound and fury,
Monetary policy may be a dead end. Perhaps it’s time to start looking elsewhere—Harrison suggests fiscal policy—for what is really driving inflation and growth.