Easy (Still) Does It

Recent measures of the economy suggest that the Federal Reserve is closer to achieving its policy goals. Its dual mandate to encourage price stability and full employment appears closer met compared with its forecasted timing.

Inflation has risen, which should ease the central bank’s concern with deflation. The latest reading for the Fed’s preferred benchmark, the personal consumption expenditures price index measured by the Commerce Department, was 1.8% — very close to both the Fed’s 2.0% target and its 20-year average of 1.9%. The widely-reported consumer price index measured by the Bureau of Labor Statistics, has risen to 2.1%.

Employment has also improved. Initial unemployment claims for the week of July 19th was 284,000 – quite low compared with the 363,000 average since the Department of Labor began its measurement and the lowest number since the peak of the housing bubble in early 2006. The national unemployment rate of 6.1% is still above historical average but is declining quickly.

We’ve received inquiries asking if the faster-than-forecasted improvements in labor and inflation would lead the Fed to accelerate the reduction of its bond buying program or to lay the groundwork for an earlier and more aggressive rise in short-term interest rates.

Our answer differentiates between what we think the Fed should do and what it will do. While we think the current employment and inflation dynamics warrant more timely normalization of central bank policy, we also believe that the Fed has prioritized employment over price stability and will intentionally be “behind the curve”. To quote chairman Yellen, “Capitalism has limitations that require government intervention in markets to make them work . . . To me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target.”

Investors should expect the Fed to remain, in their words, “accommodative”.