The Fed And Where From Here

We have to be very careful to understand what Powell was really saying, and it is not clear. He said we are “near the neutral range, but the range is 2.5%-3.5%. So all he really said was we are in a point where we still could raise three times in 2019 and still be in the neutral range at 3%. He did not say we are near ending. It is possible he was trying to deflect the pressure from Trump, the housing and auto industries, and Wall St to pause in March. There is no doubt he will raise in December.

Consumer spending was up strongly in October, and consumer sentiment is near record high.  Wages are growing at 3%, well above inflation, and year end bonuses are very likely to be very good in all industries other than housing this year. Christmas is going to be very good and likely much better than forecast. That will drive a good economy in Q1 in 2019. PCE, the inflation gauge the Fed uses was only 1.8% in October, and the Philips curve has now been proven to not be accurate, so it is possible wage growth might not be as strong as the economy and unemployment would suggest. More likely it will be bonuses that rise, and not hourly wages as much as expected. That puts cash into workers pockets, but does not raise inflationary wages into 2019.

Oil is the other main issue. At $50, it is likely to rise from here, but we will have to see what the Saudis really do with production. Trump has real pressure on them due to covering for the Prince, but at some point the Saudis need more money and will cut production. Once the pipelines are all open in the US that are completing construction, oil will flow much better and that will help keep refined prices low. US exports are rising and if Trump can push the EU to take a lot more LNG from the US instead of gas from Russia, it will ramp up even more production in the US. It is very hard to know, but likely oil will rise to $55 or maybe even 60, but that is still low and will not push inflation up a lot. The big thing is gas and heating oil prices are very low now, just in time for Christmas shopping season. This and wage increases and full time vs part time jobs, is giving the low end workers a big boost in their spending. Wal Mart and Dollar stores will have a very strong Christmas.  All of this may push the Fed to increase in March, and may push new industrial construction up.

The next inflation issue is Amazon and Wal Mart. Economists calculate that Amazon may account for as much as one half point lower inflation. Now Wal Mart has become very competitive with them, and that will further keep prices lower than they otherwise might be. Other retailers like Target are getting much better at online, so the competitive pressures on prices is increasing. Online ability for consumers to easily price compare is making a major difference in inflation. All of this is favorable to inflation so possibly the Fed will feel less pressure to raise three times next year.

Cap ex by corporations is growing nicely if you look at tech spending which is not usually included in the official cap ex figures. It is expensed so not a balance sheet item in many cases, but that is where the capital is going. So what appears to be only 3% cap ex spend is really a much higher number if all the tech investment is included and it is the tech improvements which materially increase productivity, and it is productivity that affects labor costs per unit. There is no good data on these expenditures yet, but some believe it is large and that productivity, which is inaccurately measured in the official statistics, may be improving a lot more than is in the data and that is good for lower inflation.

Now it appears Trump and Xi reached some sort of basic stand still understanding to let the subordinates try to reach a final deal. There appears to be some steps to be taken immediately to show good faith. How detailed, and how good it will turn out to be, we will have to wait to see over the coming 90 days as the subordinates work to formalize the details, and we see if China really will truly agree to stop the IP theft, and agreed to actually abide by WTO rules, which is the key issue. With China -saying and doing are very two different things. If they really agreed to finalize a deal in 90 days, and the Chinese abide by it over the next few months, then the capital markets open up, equities go up a lot, and GDP has a longer run to grow.  All that is good.  The bad is the Fed will then do three times in 2019. So goes the housing market and development.

The views expressed here are the author’s own and not that of ALM’s Real Estate Media Group.