The 'data-dependent' Fed has made a habit of using the same data to hike, not hike, and caution about future hikes

Thomson Reuters

When the Fed hiked rates in December, it concluded that "near-term risks to the economic outlook appear roughly balanced" in justifying a 1/4 point increase.  Last Wednesday, this statement was left unchanged, but the Fed decided to pass on a further rate hike.  Go figure!  Nothing surprising here as the "data-dependent" Fed has made a habit of using the same set of data to hike, not hike, or just caution investors about future hikes, as it pleases.  All the more reason for giving markets more clarity about policy with a rules-based approach such as adoption of the Taylor Rule.

And if believers in the Fed looked for last Friday’s jobs numbers to provide ammunition to support the Fed’s expectation in December to increase rates three more times in 2017, they were disappointed.  While the 227,000 jobs created in January were more than the 180,000 consensus, average hourly earnings increased by only 0.1% from December, much slower than the 0.3% monthly increase that markets had discounted.  Readers of Business Insider will recall that I said in my note last month that wage increases would not be a factor pushing up inflation or forcing the Fed to increase rates at a faster pace.  The latest jobs numbers strengthen my conclusion that Chair Yellen and her colleagues may threaten further hikes but are unlikely to tighten much further.  The Federal Open Markets Committee cannot expect inflation hitting its 2% target anytime soon to justify further monetary tightening.

What should be the Fed’s takeaway from the fact that job creation was higher than anticipated even as wage increases were disappointing?  Too many jobs are being created in low-earning positions!  Detailed information provided by the US Bureau of Labor Statistics shows that employment in food services and drinking places, at the lower end of wage-payers, rose sharply in January as well as over the last 12 months.  Employment in manufacturing and mining, where wages are higher, were hardly changed on the month.  This, in turn, ought to hold two lessons for our monetary policy makers.

First, a healthy jobs situation and a steadily growing economy are among the Fed’s stated objectives.  The wage numbers from December and January do not help the Fed’s case that things are improving on the employment front despite the high level of job creation.  Even though the increase in the labor force participation rate from 62.7% in December to 62.9% in January is positive, it remains well below the 66.0% level in December 2007 when the Great Recession began.  And those who would blame the lower participation rate on a graying US population and baby boomers who are retiring should look at the participation rate for the 25 – 54 year olds — the prime working age for US workers.  81.4% of these individuals were in the labor force in January, almost 2 percentage points less than just before the recession.

Second, the Fed tries to maintain a low, but positive, inflation rate.  Despite the handwringing about the sizable increase in hourly wages in the December report, I believed that a surge in inflation was not a valid concern because the average work week had actually declined from 34.6 hours in January 2016 to 34.4 hours in December.  And the January figure remains stuck at the same level.  If workers earn more per hour, but work fewer hours per week, not only is this an unhealthy labor market.  It is also one that is unlikely to be a factor in causing inflation to accelerate.

Does all this mean that the Fed can remain sanguine about rate hikes and continue with its zero- or low-interest rate policy?  Not at all.  The reason to increase rates, and substantially so in the current context, is that the post-financial crisis interest rate policy has caused enormous distortions that have affected investment decisions by corporations and households, and savings decisions by its residents.

By ignoring the importance of final market stability by maintaining low rates, the Federal Reserve risks repeating the conditions that set the stage for the 2008 global financial crisis that it hardly saw coming!

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