Powell takes the lead in the race for the Fed, equities price higher odds for tax reform, unemployment likely heads lower, Bernanke sees a role for high inflation and more. Contributions from Brookings, Citi, DB, GS, S&P and Milepost.
Markets: Happy Powellween
Jerome Powell has the inside track for Fed chair, according to press reports last week, with John Taylor trailing. Janet Yellen and Kevin Warsh did not get mentioned. There is some chance that Taylor could get vice chair. With the FOMC scheduled for Wednesday, the official announcement likely comes in the days afterwards. Rates on 10-year notes fell 4 bp on the Powell news since he is viewed as more dovish than Taylor. See Citibank, US Economics Weekly: Happy Powellween, 27 Oct 2017. (Citi, Milepost).
Markets: Pricing for tax reform
The performance of high- and low-tax stocks lately signal rising odds of tax reform, according to Citibank. Companies subject to high taxes and ones that benefit from fiscal spending have seen their stock surge through October. The pricing of high-tax and cyclical stocks nevertheless is well below the post-election peaks of last year. A contentious political process is apparently tempering market expectations. See Citibank, US Economics Weekly: Happy Powellween, 27 Oct 2017. (Citi, Milepost).
Markets/economy: A treat for consumers
The Fed may allow unemployment to fall further from today’s low rate if inflation looks likely to stay low, a potential boon to consumers and the debt markets that fund them. “I would generally view (structurally low inflation) as a positive, rather than negative, development,” NY Fed President Dudley said earlier this month. “It would imply that the US economy could operate at a higher level of labor resource utilization without generating a troublesome large rise in inflation.” Low unemployment would further improve consumer credit. The Fed runs the risk of pushing unemployment below sustainable levels and later forcing a sharp and disruptive campaign of fed funds hikes. Historically it’s hard for the Fed to push up unemployment without triggering recession. The market nevertheless is pricing for continued low inflation. See Goldman Sachs, US Economics Analyst: The Monetary Policy Response to Low Inflation, 21 Oct 2017. (GS, Milepost).
Markets/economy: Bernanke’s case for much higher inflation
Former Fed Chair Ben Bernanke might encourage the Fed to let inflation run well above it’s 2% target if that convinces the market that inflation will be 2% on average. The strategy would help the Fed in the future when interest rates hit zero and prevent the Fed from easing further. At zero rates, inflation could run below target for long stretches. A credible claim to let inflation run high later might stop markets from lowering inflation expectations and raising the risk of deflation. The slope of the yield curve could swing much more dramatically in the future. See Bernanke’s blog, Temporary price-level targeting: an alternative framework for monetary policy. (Brookings, Milepost).
Markets: Something special in the Treasury market
The market that finances Treasury debt is signaling a rise in short-term interest rates. Investors trying to short-sell Treasuries have helped trigger an impressive financing special. Short sellers have to put up cash and borrow the debt before selling it. Normally the investor gets some interest on the cash, but lately investors trying to borrow the newest 3-year note have had to pay as much as an annualized 2.10% rate overnight to hand over their cash – a negative repo interest rate. The special financing reflects both short-seller demand and light holdings of 3-year notes in the Fed portfolio. Normally the Fed lends securities when financing goes special. Now borrowers need to find securities in private hands, and that is becoming expensive. Special financing should push swap spreads wider. See Deutsche Bank, US Fixed Income Weekly: Treasuries, 16 Oct 2017. (DB, Milepost).
Markets/economy: The ritziest rents fall hardest
Slowly rising rent has contributed to this year’s soft US inflation, but rent in the ritziest districts is actually falling. Of the 1,000 largest US ZIP codes, the ones with average monthly rent above $3,000 saw rent through August drop year-over-year. That includes ZIP codes like 10023 on Manhattan’s Upper West Side. Rent in most other US ZIP codes rose. Upper West Siders may now have a few extra dollars to spend at Zabar’s. See Goldman Sachs, The Mortgage Trader, 20 Oct 2017. (GS, Milepost).
Markets/economy: Rent rather than buy
Renting looks more affordable than owning to 76% of renters, according to a Freddie Mac study released last week, up from 65% a year ago. Convenience and flexibility came out as the top reason for renting instead of owning across all age groups. Preference and lifestyle more than necessity may now be driving the decision to rent. The Freddie Mac study is here. Both home prices and rents could be experiencing upward pressure, however, from an unlikely source. S&P reports that an unpublished paper points to Airbnb as pushing up both home prices and rental costs. The unnamed study focused on the 100 largest US metro areas between 2012 and 2016 and found that a 10% increase in Airbnb listings results in a 0.39% increase in rents and a 0.64% increase in home prices. Of course, rising rents and home prices might just be forcing more people to list on Airbnb. (S&P, Milepost).