Markets were relatively quiet yesterday, searching for a catalyst. Since May 1, the S & P 500 has had a narrow rebound following a 4.2% drop in April, a decline primarily the result of yet another in change monetary policy expectations.
Neel Kashkari of the Minneapolis Fed commented yesterday “The Committee has more work to do if inflation is going to settle around 3.0%. The basis for his comments is that the core PCE or the primary determinate of monetary policy, averaged 2.9% so far this year, above the 2.6% the Committee estimated in its March dot plot, which in itself marked an upward revision.
While the April jobs data was softer than forecasted [and a primary catalyst for the recent equity advance], the average jobless rate this year is 3.8%–well below levels that the Fed believes will be needed to bring the labor market back into balance.
Kashkari believes the neutral rate, or the rate where the economy is at full employment and inflation steady, is still elevated at 1.12%.
This compares with the Fed’s implicit assumption of a 60-bps real neutral rate on its summary its March summary of economic projections.
Kashkari states if the core PCE remains around 3% assuming is his models are correct, the implied nominal policy policy rate will be north of 4.1% versus the Committee’s projection of 3.2%.
If this is indeed the case, the odds of a reduction in the overnight rate are extremely low and longer-term Treasuries—defined as 10 years or longer—are expensive.
Kashkari is not a voting member of the FOMC and is regarded as one of its more hawkish Committee members. He has also been largely correct about inflation over the past 24 months.
Will his comments be regarded as prescient?
Next week both the CPI and PPI are released. This data can influence outlooks.
What will happen today?
Last night the foreign markets were up. London was up 0.45%, Paris up 0.14% and Frankfurt up 0.46%. China was up 0.83%, Japan down 0.34% and Hang Seng up 1.22%.
Futures are down about 0.2% searching for a fresh catalyst to move in either direction. The 10-year is off 11/32 to yield 4.52%.
SEARCHING FOR A CATALYST; A HIGHER NEUTRAL RATE?
Kent Engelke
Chief Economic Strategist Managing Director
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