Cumberland Advisors Market Commentary – To Pass or Not to Pass? (Part 1)

Ohio State’s Woody Hayes used to say that his problem with the forward pass was that “Three things can happen, and two of them are bad.” Well, after Chairman Powell’s testimony last week, the FOMC may find itself in a similar position, only maybe worse.

Federal Reserve - FOMC - Uncertainty, Risk, & Three Options

The Committee can do three things – lower rates, keep rates steady, or raise rates – and in this case all three options have potentially negative consequences. Let us consider the kinds of fallout that might occur from each, starting with the easiest option, raising rates.

Raise Rates – Clearly, if this option were selected, it would totally surprise everyone – markets, both bond and equity, as well as politicians. Such a move would negate all the messaging that has preceded the FOMC’s upcoming July meeting and make the Committee look erratic and out of touch with what is going on in the economy. Criticism about competency would also be leveled. Such a move has no probability of happening.

Keep Rates As Is – Opting not to change rates would also be a surprise to markets and would have to be sold based upon yet-to-be seen incoming data. While there is a host of forthcoming data, the first estimate of second-quarter GDP is critical. The FOMC and Chairman Powell will be hard pressed to sell a no-rate-decrease policy, especially after having glossed over the most recent jobs report. The second-quarter GDP number will further expose the divisions within the FOMC about when and whether a rate change is warranted. Reserve bank presidents Bostic and Barkin have now gone on record as not being convinced that a rate move is needed, and other reserve bank presidents will be speaking before the July meeting on both sides of the issue. Finally, no change would also fuel additional speculation about the next and subsequent meetings. This is the Chinese water torture policy option.

Lower Rates – The riskiest option of the three for the FOMC may be to move rates down, by say 25 basis points. Chairman Powell has already attempted to justify a rate cut because of uncertainties about global growth and trade issues. The best that the FOMC can hope for is a sub-trend second-quarter growth number, whereupon they could attempt to sell the rate decrease as an insurance move to keep the expansion moving.

There are several problems with this strategy. The first is political. Regardless of the stated rationale, President Trump will point to the fact that the FOMC’s move confirms his assertion that the last rate increase was too much, that he was right and the FOMC was wrong, and that they didn’t know what they were doing. His access to the media and his captive audience far outweigh that of the Fed, so the FOMC’s voice will be drummed out. Most unsettling would be the perception that the FOMC caved to political pressure and has now put its independence at real risk, inviting even more armchair policy making, notwithstanding recent expressions of support by people on both sides of the aisle at the recent congressional hearings. Not only is there a critical threat to the Fed’s independence, but also a rate decrease will only give rise to market participants arguing for at least an additional 75-basis-point reduction through the end of the year. Thus, the drumbeat for more and more accommodation would continue, and the FOMC would face increased market and political pressure to deliver more. In other words, a 25-basis-point move solves nothing, holds little chance of being credibly sold, uses up valuable policy flexibility in the case of a recession threat, and only creates more problems going forward.

The Messaging Problem – At this point the FOMC faces a real messaging problem. To illustrate, Chairman Powell repeatedly emphasized the problem of uncertainties about a global slowdown and tariffs in his recent monetary policy testimony. For an economist to use the term uncertainty means that he or she cannot estimate the probability that an event will occur or what its consequences will be. On the other hand, to use the term risk means that one has a view about the likely probabilities associated with the events of concern. There are no economic models that can provide any meaningful guidance as to what the consequences of a policy move to counter uncertainties are or will be. We do have some ideas about how to address risks. To complicate matters even more, either a trade war or a global slowdown is unlikely to have a measurable impact on the core of our economy. Trade is a small portion of GDP, and the so-called trade uncertainties that have been in place as of last year had no noticeable impact on first-quarter GDP growth, which came in at 3.1%. In fact, the most recent data indicate that our trade deficit with China has actually increased rather than decreased, in spite of the tariffs that have been put in place. The impact of a global slowdown are also questionable. Global growth has been slow for at least a year, and it isn’t clear how it has affected us or what impact an “insurance” policy rate cut might have or how big it should be.

In short, unlike in the case of the forward pass, where at least one positive result might be realized, the FOMC has painted itself into a corner where none of the three options available to it in the short run are likely to result in positive outcomes, either economically or politically.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

Read Part 1 here: To Pass or Not to Pass? (Part 1)
Read Part 2 here: To Pass or Not to Pass? (Part 2)
Read Part 3 here: To Pass or Not to Pass? (Part 3)


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Cumberland Advisors Market Commentary – Clams or Gold

Johnny Hart, the creator of the comic strip BC, created an economy in which clams served as currency. Clams were plentiful, so no one ran out of currency, except that an occasional clam had cartoon legs and opted for a different career. A currency in the form of a good is of course nothing new in the history of world economies, but one good – gold – seems to have legs that have endured the test of time, or so we are led to believe. The argument is that a gold-backed currency provides a stable store of value and discipline when compared to fiat currencies.

Cumberland Advisors' Bob Eisenbeis

Such a currency requires a government standing ready to convert the currency into gold at a fixed price – the government cannot increase the supply of money without having enough gold to meet its redemption obligations. A similar argument lies behind cryptocurrencies like Bitcoin, whose production, like that of gold, is dependent upon mining – in the case of Bitcoin through the use of computers to solve a mathematical problem. In both cases, real resources, combined with a limit on the outstanding quantity of those resources, natural or otherwise, are needed to increase the amount of gold or Bitcoins outstanding. They do not depend on reliance upon governments to responsibly manage the supply of fiat money.

The stability arguments for such arrangements, however, are not borne out by history, especially when we look at the events surrounding the Great Depression, where adherence to the gold standard led to a collapse of the US money supply and a worldwide economic slump. Because of Europe’s need to finance World War I, it incurred substantial deficits to the US in purchasing war-related goods. Gold flowed into the US; and to offset the increase in the money supply that the inflows implied, the Federal Reserve sold bonds in an attempt to sterilize the inflationary pressures. When the Great Depression hit, the inflows of gold required the Fed to contract the money supply instead of expanding it to stimulate the economy. Friedman and Schwartz claim that the money supply declined by one-third, exacerbating the economic decline.

As another example, the price of gold at the end of 2000 was $272.65 per oz., as compared to $1392.35 as of July 9, 2019, which represents an implied compound rate of inflation of about 9% per year, as compared with the average change in the CPI of 2.1% per year over that period. At a rate of increase of 9% per year, it would take only about eight years for the price level to double. Hardly an endorsement for the stability of gold as a benchmark to which to tie our currency.

While some push the benefits of the gold standard, it may be worthwhile to take a look at some key questions before we opt to potentially turn over a key component of our monetary base to outsiders. Since a return to a gold standard would tend to benefit those who have the gold, it is fair to ask who owns the existing gold stock, where known deposits of gold are yet in the ground, who stands to gain the most from mining their existing stocks, and how long mining might continue until the known stocks are exhausted.
In terms of ownership of the existing gold stock, EU governments and central banks are the largest holders of gold, with about 9,817 metric tons, worth about $445 billion at current prices, an amount that represents about 32% of all government and central bank holdings of gold. The US is second with 8,122 metric tons, worth about $369 billion, which is about 26% of the world total. Interestingly, the IMF is in third place with 2,814 metric tons, worth about $128 billion, or 9% of the world total. China and Russia follow, each holding about 6% of the total.

But world holdings of gold are only part of the picture. Going forward, it is important to know who the key producers are and where the known reserves are located. The biggest mines in order of size are in Indonesia (Grasberg mine), South Africa (South Deep mine), Papua New Guinea (Lihir mine), Russia (Olimpiada mine), Dominican Republic (Pueblo Viejo mine), and Australia (Boddington mine). The following table shows the countries that are the key producers of gold and what their estimated in-ground reserves are.

Not all the gold produced goes into currency reserves. In fact, typically only 25% of annual production goes into gold bars and currency, while another 5% is absorbed by central banks. Jewelry accounts for about 52% of production, with the only other significant use being in the manufacture of certain electronics.
In terms of US production, our 221 metric tons per year would be valued at about $10.9 billion per year. To put that number in context, between 2017 and 2018 the Fed had to increase its balance sheet by about $100 billion, just to accommodate the increase in currency demand. That’s an amount about nine times the value of the gold reserves available to be mined in the US. This means that were the US currency to be backed by gold, the Fed would have to purchase about two-thirds of the world’s production annually at current output levels. Furthermore, if only the US were to go on the gold standard, this move would create a windfall for those countries with large gold reserves and would also put the US money supply at the mercy of Russia, China, and a few other countries who are not our strongest allies at the moment.

Finally, given that world’s economies are continuing to grow, the demand for whatever commodity was used to back government money supplies would also need to grow at pace. If currencies are backed by gold, supply would need to keep up with demand or the price would skyrocket. Provident Metals has reported that, based upon known supplies of gold in the ground and assuming that about 3,000 metric tons of gold are mined every year, it is likely that mining would become economically unsustainable by about 2050.
Given the limited supply of gold reserves, the lack of price stability, the fact that the large known in-ground reserves are located outside the US in some not-so-friendly countries, and the fact that over 52% of existing production is absorbed by jewelry demand, gold may be one commodity that is better used for decoration and jewelry than to support currencies and financial markets. What is equally clear is that we don’t want to base our money on clams located on someone else’s beach.

Bob

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


EDITOR’S NOTE: A follow up piece was written by Robert Eisenbeis, Ph.D. which includes replies to comments and questions submitted by you, our community and audience. Read it here: Clams Or Gold Responses


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Cumberland Advisors Market Commentary – Jobs and Other Thoughts

Earlier in the week, before July 4th, ADP released its jobs report for June and predicted that the economy had only created a modest increase of 102K jobs on the heels of May’s 75K. The press picked up that number with headlines like “Job Creation Has Another Rough Month in June as Private Payrolls Rise by Just 102,000.”[1]

Market Commentary - Cumberland Advisors - Employment Report

Economists who responded to a Dow Jones survey on expected June jobs were nearly as pessimistic, forecasting only a 135K increase. Those forecasts on the eve of the July 4th holiday led markets to believe that a continued softening of the economy would provide the needed ammunition to justify a reduction in the FOMC’s policy rate later in July, and as a result markets closed at an all-time high on Wednesday.

Now we have the CES and Household Survey results for the month of June from the Bureau of Labor Statistics, showing that the economy actually created 224K jobs, more than double the number projected by ADP and above the average of 172K per month for the first six months of this year. Moreover, there are many positive elements to those job numbers. The unemployment rate held steady at 3.7%. There were healthy increases in business and professional services, health care, transportation and warehousing, manufacturing, and most notably, a 21K increase in construction jobs, despite what has been claimed to be a slowdown emerging in housing. Other major categories showed little change for the month. Finally, there was a gain in average hourly wages, which are now up 3.1% on a year-over-year basis.

All of this positive news disappointed markets, with the Dow down 130 or so points by midday Friday, July 5th , before ending above the day’s opening. This response unfolded because the prospect of a rate cut, which had been priced in, now looked problematic and resulted in a reassessment.

What can we learn from this episode? First, it seems clear that it may be risky to put too much weight on a single data release, in this case on the ADP report. The size of the miss raises the question of how good of a predictor of the CES jobs report the ADP report is, keeping in mind that these two reports are compiled differently. The ADP report is based on data from approximately 400K businesses that are clients of ADP, and it is compiled by Moody’s. The CES report is based on a monthly survey of a much smaller set of about 142K businesses, but covering over 680K jobsites in the US.

If one runs a simple linear regression using the ADP release to predict what the CES jobs number will be, a number of interesting conclusions emerge. Below is a brief summary of that regression, spanning April 2002 through July 2019.[2]

CES = 7.633 + .969 x ADP

Adjusted R-square = .754

The overall explanatory power of the regression within sample is quite high and about on par with average results for time-series data like the employment series. That is, the equation explains about 75% of the variation in the CES survey. So, for every 100K jobs that were created according to the ADP survey, the prediction would be 90.7K jobs for the CES survey. However, even more interesting is what the ADP forecast errors look like from month to month. The absolute mean forecast error (that is, the average absolute size of the error regardless of whether it is positive or negative) is 78.9K. The biggest prediction errors were in the immediate aftermath of the deepening of the financial crisis in 2009. In March of 2009 ADP predicted a decline of 417K jobs when the CES number showed a loss of 803K jobs. In November of 2009 ADP predicted a loss of 373.8K jobs, but instead the CES data showed a gain of 12K jobs. The ADP survey consistently missed big during much of 2009 and 2010, and this record may explain why Moody’s modified the methodology in November 2012. Looking at just the performance after the November 2012 methodology changes, a regression on the smaller sample size yields quite a different equation than a regression for the entire period since 2002. The following is the new equation:

CES = 68.57 + .695 x ADP

Adjusted R-square = .209

The overall power of the equation is substantially lower than that of the full-sample equation shown above explaining only 20% of the variation in the CES. However, given the relatively stable period after 2012, the absolute mean forecast error is now somewhat smaller. at 54.83. Looking at the over and under predictions since 2012, the biggest miss on the down side was for the month of July 2016, where ADP forecast 151.8K jobs being created, whereas the CES number came in at 336K. The biggest over prediction was for the month of February 2019: ADP predicted that 219.9K jobs would be created when the CES reported 56K new jobs.[3]

This brief dive into the ADP data again highlights the point made at the outset of the commentary; and that is, when it comes to economic forecasting, it is risky to bet on one given forecast or estimate. A colleague once put it this way: “When one lives by the crystal ball, one occasionally has to eat broken glass.”

As for what the FOMC will do this month, our view has been and continues to be that the Committee will keep its powder dry and wait for more incoming data. The first look at second-quarter GDP will now be extremely critical as will Chairman Powell’s testimony later this week.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio
________________________________________


[2] The ADP data start in 2002 in the St Louis Fed’s FRED data base.
[3] As one last check, a regime-shift equation was estimated, allowing for a parallel shift in the estimated equation, separating the pre- and post-November 2012 period. The new equation is CES = 4.118 + .956 x ADP + 12.26 post-2012, and the adjusted R-square is now .75, about the same as that for the full sample. Interestingly, the equations would have all been off by about 100% for the July 2019 CES jobs number.

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The June FOMC

In the commentary leading up to the June meeting, I argued that some relaxation of the tariff issues with Mexico, combined with relatively good data for the US economy, would make the FOMC’s decision to hold pat on rates relatively easier.

Federal Reserve - FOMC

While the FOMC did decide at its June meeting to hold rates constant for the moment, the dot charts and dissent by President Bullard suggest that a number of participants were closer to cutting rates than they may have been previously or than observers might have expected leading up to the meeting. The statement itself, as many have noted, deleted the word , and the FOMC also dropped its characterization of ongoing economic activity from “solid” to rising at a “moderate rate.” We need to remember that the minutes of the March meeting indicated that the staff forecast had included a markdown of growth after Q1, so the change in language validates that forecast and aligns with the districts’ characterization of growth in their regions.

The deletion of the word patience really reflects two considerations. First, the Committee expressed concerns that downside risks had increased, and Chairman Powell made it clear in the press conference that those concerns were driven by uncertainty about US tariff policies and global growth. The FOMC statement did note that inflation expectations for the near term had declined, but longer-term expectations remain well anchored. Clearly, the failure to achieve its inflation objectives was not a determining factor in the FOMC’s decision to maintain current rates.

Second, while the word patience was missing, it was also the case that policy would be dependent on incoming data, and that view hadn’t changed one bit. Instead, the deletion of patience indicated the FOMC’s concern about the risks to the expansion and reflected the Committee’s shift from a “steady as you go” policy stance to “on your mark.”

How far are we from “get set, go!” is now the critical question; and at this point, as former Federal Reserve Bank of Philadelphia President Charles Plosser noted on Bloomberg Asia after the meeting, we are rather in the dark as to what the FOMC’s reaction is likely to be to the incoming data. The key incoming data for the FOMC’s July 29–30 meeting will the June jobs report on July 5 and the first look at the advance estimate for Q2 2019 GDP on July 26.

We can also glean some useful information on how the FOMC participants’ views on policy have changed from a comparison of the dot plots from March to June.

Bob Eisenbeis FOMC Chart 20190624

First, looking at the December projections, we see a significant shift and difference of opinion as to whether rates should be raised or lowered. While six people favored at least one or two rate increases in March, all but one had significantly lowered their rate recommendations in the June SEP. Eight people continued to favor holding rates between 2.25–2.5%, while all the remaining participants favored at least one rate cut by the end of 2019. Similarly, for 2020, of the 10 participants who saw rates above 2.5% in March only three now saw rates that high, while nine saw rates below 2.25%, and seven saw rates between 1.75–2.0%. Finally, for 2021, views have further diverged, probably reflecting the uncertainties that participants now feel may exist after the 2020 election. These projections appear quite bearish, given the fact the interest rates have come down in the near term from where they were in March. Mortgage rates are now hovering at about 3.9%, more than a percentage point below where they were at the end of 2018. More generally, the Chicago Fed’s National Financial Conditions Index is almost as low as it was in 2007 before the Fed started to raise rates. Given the state of the labor market and general health of the economy, it remains a puzzle as to why the FOMC has now changed its view regarding the appropriate path for interest rates going forward.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


1) It is now clear in Fed-speak that solid means that growth is faster than “moderate,” which usually means growth at about 2.2–2.4%.


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Trump revs up his Wayback Machine

Excerpt from…

Trump revs up his Wayback Machine

In a single week, the president leaned heavily into economic theories from as far back as the 18th century.

By BEN WHITE (bwhite@politico.com; @morningmoneyben)
06/20/2019 05:15 AM EDT

Cumberland-Advisors-Robert-Bob-Eisenbeis-In-The-News

Stanley Fischer, the former Fed vice chair, said at a forum Tuesday that slashing rates right now following pressure from Trump “would destroy the independence of the Fed,“ adding “it’s not something that should be done.”

Economists also note that monetary policy remains fairly loose and that one or two cuts is not likely to address damage from Trump’s trade policies.

“Realistically, a cut in rates is not going to counter the damage to farmers trying to sell their soybeans,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors and former research director at the Atlanta Fed. “A rate cut is pretty far removed from the damage the administration is doing with their tariff policy. If you are a farmer or a car maker trying to figure out what to do, it doesn’t help you.”

Trump also signaled this week that he may not wind up cutting a deal with China.

Read the full article at POLITICO.com .


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More on Tariffs

Assessing the impact of the series of US tariff changes in 2018 and 2019 is difficult. The tariffs have been revised and updated over time. Indeed, MarketsInsider lists about 27 tariff-related events and announcements between March 2018, when President Trump announced tariffs on steel and aluminum imports from all countries, and May 23, 2019.[1] They have involved different countries and have impacted literally thousands of products. Sometimes tariffs have been imposed without allowing enough time for buyers of the products to arrange new suppliers or to make other supply chain adjustments. Still, it may still be possible to assess the impact of the tariffs based upon work done by independent groups like the Tax Foundation, the Peterson Institute for International Economics, and various Federal Reserve Banks.

Contrary to public opinion, the first round of tariffs on Chinese imports was not focused on consumer goods but rather mainly on intermediate goods and capital goods, which amounted to products worth about $32 billion against which tariffs would be levied. The following graphic shows the breakdown. In the case of these products, the importer paid the tariff and either absorbed the cost, negotiated a lower price from the China supplier, and/or passed the price increase on to the final goods producer as an input cost increase.

Policy changes in June 2018 added some products to the China import quota list and dropped others. For example, flat-screen televisions and aluminum were dropped, while tariffs were imposed on semiconductors and plastics. Changes were also made to components of other intermediate and capital goods. Not long after these tariffs were imposed, impacted countries responded with tariffs on US exports. The following table details those tariffs. The impact of China’s tariffs on US agricultural products is clearly significant. But interestingly, the impact was delayed, since much of the crop had already been planted and pre-sold. However, come fall, substitute crops in Brazil were planted and subject to sale to China. The real impact on US farmers didn’t show up until this planting season, when demand has dried and prices have been halved.

Since the initial rounds of import and retaliatory export tariffs have been imposed, many changes have been made in US policies, and the US has negotiated a revised trade agreement with Canada and Mexico, known as USMCA, which has yet to be approved by Congress. For example, the US lifted tariffs on steel and aluminum imports from Canada, Mexico, the EU, South Korea, Brazil, Argentina, and Australia in March, 2018. But then in June of 2018 the US removed the steel and aluminum exemptions for the EU, Canada, and Mexico, resulting in a 25% tariff on steel and 10% tariff on aluminum from those countries. Predictably, the affected countries retaliated with tariffs on US exports, detailed in the table above, that included whiskey, boats and yachts, motorcycles, blue jeans, corn, and peanut butter. Note that the tariffs imposed on most of these products and others listed in the table above impact farmers in the Midwest and manufacturers in Ohio, Michigan, and other states that supported the president in 2016. At first, it appeared that the US and China might agree on a compromise trade deal, but in early May 2019 negotiations between the US and China came to a standstill, and both countries have now imposed additional tariffs on each other’s goods.

Now, in an abrupt departure from normal trade negotiations, the administration has suddenly imposed a 5% tariff on all Mexican exports to the US as a tool to force the Mexicans to do more to stem the flow of asylum seekers through their country to the US. Furthermore, the tariffs would increase by five percentage points each month until 25% is reached unless Mexico deals with the immigration issue. Left unspecified is what steps Mexico should take, but more upsetting is that this apparent switch in policy seems to be absent a tariff strategy and puts the USMCA agreement in limbo. The uncertainty that this surprise policy has introduced is reflected in reactions not only from the US Chamber of Commerce but also from investors.[2] The Dow Jones index dropped over 350 points on Friday, May 31. Some have argued that the administration has exceeded its executive powers and that Congress should step in to address this issue. Indeed, key Senate Republicans have stated that they don’t support the proposals to impose tariffs.[3]  Stop-and-go, kneejerk government actions without a cohesive strategy have far-reaching economic implications for business decision making and are not good for the economy or for international relations.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio





May FOMC Minutes: Patience

In advance of the release of the FOMC’s May minutes, speculation in the press and by financial market participants was that the Committee might cut the federal funds target rate. The main line of conjecture centered on how long the FOMC could continue to miss its inflation target on the downside before a rate cut was warranted.

Federal Reserve - FOMC

Clearly, given the lowest unemployment rate in 50 years but with inflation still running persistently below target, current economic conditions present a policy dilemma for the FOMC that is reflected in the widely differing views of FOMC participants. For example, President Rosengren, FRB Boston Bank president, notes that the current conditions are arguably sending conflicting signals, with the unemployment situation implying that there is a case for raising rates, while below-target inflation suggests that a rate cut would be appropriate.[1] On balance, however, Rosengren views the below-target inflation situation as temporary and financial conditions as accommodative. Thus, he sees no need for a further rate move at this time. In contrast, FRB St. Louis Bank President Bullard said on Wednesday, May 22, that a rate cut might be appropriate:[2] “A downward policy-rate adjustment even with relatively good real economic performance may help maintain the credibility of the [Federal Open Market Committee’s] inflation target going forward. A policy rate move of this sort may become a more attractive option if inflation data continue to disappoint.” President Evans of the Federal Reserve Bank of Chicago has voiced similar concerns about the failure to hit the FOMC’s inflation target.[3] Finally, Governor Brainard’s recent observation is symptomatic of the puzzlement over why inflation has been persistently below target: “Of course, it is not entirely clear how to move underlying trend inflation smoothly to our target on a sustained basis in the presence of a very flat Phillips curve. One possibility we might refer to as ‘opportunistic reflation’ would be to take advantage of a modest increase in actual inflation to demonstrate to the public our commitment to our inflation goal on a symmetric basis.”

Clearly, this is just a musing on her part, since inflation has not been above target for any relevant period of time. Hence the view that the FOMC cleaves to a symmetric view of inflation policy (and thus deems it sometimes acceptable for inflation to be somewhat above or below target) is at this point conceptual rather than a reflection of recent history. The FOMC’s reference to its pursuit of a symmetric inflation policy raises addition complications, considered below.

But first, it is useful to illustrate just how long inflation has been below target. The following chart shows the year-over-year percentage change in the FOMC’s preferred inflation metric (headline PCE) since it was adopted in early 2012, relative to the 2% target. The chart demonstrates that inflation was continually below target until it briefly exceeded 2% in January 2017, but it did not subsequently exceed 2% until early 2018, and then dropped again to the present level. That persistence doesn’t appear to the layman’s eye to reflect the temporary pattern that FOMC participants seem to see – notwithstanding their recent references to current component price movements that are presently below target and viewed as transitory.

The constant speculation about likely rate increases or decreases is rooted partly in the FOMC’s communications policies and the market’s lack of understanding of what the FOMC’s reaction function is to deviations from its inflation target and unemployment objectives. The FOMC does not have an explicit unemployment objective, since its position is that it can’t affect real outcomes in employment or long-term economic growth through the use of monetary policy. But given the Committee’s specific inflation target, it is reasonable for markets to ask the following set of questions.

  • -If inflation is below or above target, how long must that condition persist before a rate move is contemplated?
  • -Is there a critical value in terms of the deviation of actual inflation from target that will trigger a policy response, and is the response at all related to the rate of growth or decrease in the inflation rate?
  • -Is the reaction function different if inflation is above target as opposed to below target?
  • -Is the reaction function different if both inflation and unemployment are low, rather than inflation being low and unemployment increasing?
  • -Similarly, how does the Committee view its policy decision-making when inflation and growth are accelerating?

Absent a clear understanding of how the FOMC views its policy choices, markets are left to speculate. Revealed preference on the part of the Committee at least provides circumstantial evidence about the FOMC’s reaction function. In the current conflicting-signal environment, the FOMC has proved willing to tolerate inflation’s remaining persistently below target for an extended period of time (i.e. many years), given that growth is about on trend and consistent with the Committee’s forecasts. The watchword in this case, reiterated many times and again in the May minutes, is that the Committee can be “patient.” What it will do in other circumstances we don’t know. We suspect, given the Committee’s ongoing review of its policy framework and balance-sheet normalization, that it will deal with the circumstance when it is time. It is probably unrealistic to expect the Committee to be willing to commit to policy reactions in advance. Hence, the speculation will continue.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


 




Cumberland Advisors Market Commentary – Tariffs – Macroeconomic Versus Microeconomic Effects: In the Long Run We Are All Dead

Robert Brusca of FAO-Economics details some interesting information on US trade and the likely impacts that the current US-China trade war could have on prices.[1]

Market Commentary - Cumberland Advisors - Impact of Tariffs

He has provided us with a deep dive into the mechanics and macro costs of the current tariff “war.” Here are data suggesting that markets may have overreacted to this week’s round of tariff increases and their implications for the US economy.
1) US total non-petroleum imports amount to about 9.5% of US GDP, while US imports from China, though large in dollar amount, account for about 15% of US total imports, or only 1.4% of US GDP.
2) The president has increased tariffs on goods from 10% to 25%, a 15% increase on potentially 1.4% of US GDP, so the first-round impact is less than a 0.2% increase in price pressures and about .4% for the full impact of the 25% tariff.
3) Brusca clearly demonstrates that, despite the administration’s assertions, US importers initially pay the tariffs, not the Chinese exporters, and these prices are then either passed on to US consumers and/or absorbed by the importers in the form of lower profits. Of course, these tariffs increase the relative price of Chinese import products and mean that over time demand will be reduced and customers will substitute goods from other non-Chinese sources or change the mix of goods purchased, thereby lowering the impact of the tariffs in the longer run. Fortunately, ready substitute suppliers exist for most of the goods imported from China. Of course, there are exchange-rate implications as well.
4) Finally, Brusca argues that the overall price impacts in terms of changes in the CPI will be small, since goods have less than a 20% weight in the overall CPI.
5) To be sure, on selective products US producers may engage in parallel pricing behavior; and in some markets, like appliances, the price impacts already have been quite significant.

What about US exports, since China is raising tariffs on its imports from the US in retaliation?

1) US exports in total are about 13% of US GDP, of which goods account for about half, or 7.9%, of GDP. Services are not that important to our trade with China. The Washington Post reports that in the six-month period ending in March 2018, U.S. exports to China have dropped about $18.4 billion, some of which was offset by increases to other areas in the world.[2]
2) Total US exports to China amount to only about 6% of US total exports, or 0.6% of GDP.
3) While these aggregate macro statistics seem small when weighed against the size of the US economy, this does not mean that the tariff situation has not caused problems for key sectors of the US economy, especially agriculture, or to particular parts of the country. For example, for selective producers, like soybean farmers, the damage to their short-run and long-run production and income from the first round of tariffs (not to mention what might happen this time) has been devastating. Particularly hard-hit are farmers in North Dakota and Iowa. In 2017, China bought about $12 billion in soybeans, or approximately 25% of the US crop. In 2018 US exports of agricultural products totaled $9.3 billion, and soybeans were $3.1 billion.[3] By March of this year the figure was down to $1.8 billion.
4) Other segments hit to date have been tech and autos. Particularly hard-hit have been the states of Ohio, Michigan, Minnesota, Illinois, Iowa, Tennessee, Washington, and California. Many of these states have been supporters of the Trump administration. Funds have been allocated to provide a safety net for agriculture, but such subsidies are at best temporary, and they come out of taxpayers’ pockets. Moreover, why is it that farmers are subsidized when other producers who have been and will be adversely impacted are not singled out for support as well? Which ones will get subsidies and which ones will not? This is one game where timing is everything.
5) Finally, recent research from Columbia University on the impacts of the 2018 tariffs reveal several important conclusions. The costs to the US economy of those tariffs through the first 11 months were about $6.9 billion or .03% of GDP.  Furthermore, the costs of those tariffs were entirely born by the US and passed through in the form of higher prices with little estimated impact upon prices received by exporters to the U.S. Interestingly, US domestic producers also raised their prices.[4]

In summary, the current trade war is playing out on two fronts. At the macro level, tariffs and trade have, at best, a small and second-order knock-on effects on the US economy. Those who are predicting dire consequences are selling both our economy and producers short. However, the fact that the macro implications are minor at this date does not mean that the microeconomic impacts, especially in critically politically important parts of the country, are small or can be ignored. People and producers are being hurt, and it is often the smaller farmers and manufacturers who are not only being hurt but being driven out of business. These people won’t be around in many cases when the trade war is resolved, and the economic and political fallout from their losses will be important. Indeed, recent data suggest that family farm bankruptcies are on the rise.[5] There is an old saying in economics: “In the long run, we are all dead.” Let us hope this does not apply to the US agriculture and small-business manufacturing sectors.


[2] See “The First Round of China Tariffs Already Stifled U. S. Exports,” Washington Post, May 16, 2019.
[4] See Amiti, Redding and Weinstein, “The Impact of the 2018 Trade War on U.S. Prices and Welfare,” Discussion Paper DP13564, Centre for Economic Policy Research, March 2, 2019.
[5] See “Corn, Dairy Farms Lead Chapter 12 Bankruptcy Filings, Report Shows, Mike McGinnis, Successful Farming, March 27, 2019. https://www.agriculture.com/news/business/agriculture-leads-bankruptcy-filings-report-shows



Cumberland Advisors Market Commentary – Hope Is Not a Strategy

On Wednesday, the FOMC left its policy stance unchanged. This decision was consistent with the message sent after the previous meeting and was not contradicted by speeches given by FOMC participants in the intermeeting period.

Federal Reserve - FOMC

This action was also consistent with the consensus view of economists who follow the Fed. Indeed, of the 39 economists responding to the April 23–25 Bloomberg poll, only two had forecast a rate cut in 2019 while the rest had the funds rate target steady through 2020.[1] Despite this data, the stock market declined after the FOMC statement was released, indicating that a rate reduction had been expected but not delivered. The market continued to decline over the next two days. In contrast, on Wednesday, May 1, the ten-year Treasury rate rose at about 10 AM and then jumped even higher just before the release of the FOMC statement at 2 PM, then dipped slightly before the meeting, as the Bloomberg chart below indicates. It then recovered to pre-10 o’clock announcement levels after Chairman Powell’s press conference. How can we explain these reactions to the information flowing from the FOMC meeting? Why was the stock market’s reaction more prolonged than the Treasury market’s was?


Source: Bloomberg

 

In the case of the stock market, rhetoric from some politicians and even a now-former Fed nominee argued that the FOMC had made a mistake in raising rates in December 2018 and that time was ripe for a rate cut. Economic growth appeared to be slowing through 2018, with Q3 growth below Q2 growth while Q4, at 2.2%, was below Q3’s 3.2%. Participants were expecting a modest number for Q1 2019, especially since first-quarter growth had been slow for the past five years and we had a full government shutdown for a full one third of the quarter. Everyone expected the shutdown to subtract from Q1 growth. Finally, in addition to expected slow growth, part of the rationale on the part of those expecting a possible rate reduction lay in the fact that inflation had been running persistently below the FOMC’s 2% target, and thus at some point a rate cut would be necessary to further stimulate inflation via extraordinary monetary accommodation until the target was achieved.

Of course, we learned that this scenario did not match the view of the FOMC. Chairman Powell, in his press conference, countered the idea that inflation was “persistently below target” when he stated that the decline in inflation in 2019 was not only expected but also was viewed as being due to “some transitory factors.”[2] If markets had assumed that inflation below target was persistent and hence would soon require a rate increase – especially if the FOMC was as committed to its inflation objective as it was to the other leg of its dual mandate – then Chairman Powell, when questioned by an astute reporter, effectively shut down the possibility of a near-term rate cut to achieve the FOMC’s inflation objective. Nancy Marshall-Genzer asked, “You were saying if inflation does stay low and these low inflation rates are not transient, you said a couple of times you’ll take that into account with monetary policy. How, specifically, will you take that into account?” Chairman Powell’s response was extremely vague. He stated, “It’s hard to say, because there’s so many other variables. Ultimately, there are many variables to be taken into account at any given time, but that’s part of our mandate. Stable prices is half of our mandate and we’ve defined that as 2 percent, so we’d be concerned and we’d take it into account.” The reporter pushed further asking whether an interest-rate cut would be possible, and Powell responded that he could not be more specific.

That interchange, combined with Powell’s use of the word transient, was interpreted by markets as indicating – as the economists’ Bloomberg predictions had implied – that policy was on hold for the foreseeable future. There would be no rate cuts to satisfy stock market investors’ desire for more stimulus; and as far as the Treasury market was concerned, the meeting was a blip, as it returned to its pre-meeting position. If there was any doubt, the 3.2% Q1 preliminary growth estimate, coupled with Friday’s CES report of a 3.6% unemployment rate and over 263,000 jobs created in April, clinched the fact that no rate cuts are on the horizon. Interestingly, if the FOMC meeting had been a week later, there would have been no shock to the stock market. The lesson here for stock market investors is that hoping for a rate hike as a substitute for considered analysis is not a good strategy.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio





The Fed Decides (Radio Podcast): Bob Eisenbeis on Bloomberg Markets

Federal Reserve officials left their main interest rate unchanged and continued to pledge patience as they grappled with conflicting currents in the U.S. economy. Discussing the decision and Fed Chair Powell’s press conference are Bloomberg Markets Editor Joe Weisenthal, Bloomberg News Stocks Editor Dave Wilson, Former President of the Minneapolis Fed Gary Stern, Ira Jersey, Bloomberg Intelligence Chief U.S. Interest Rate Strategist, Bloomberg News Bond Reporter Alex Harris and Bob Eisenbeis, Vice Chairman and Chief Monetary Economist at Cumberland Advisers. And we Drive to the Close with Ryan Detrick, Senior Market Strategist for LPL Financial. Hosts: Carol Massar and Jason Kelly. Producer: Paul Brennan

Running time 41:10

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Cumberland Advisors on Bloomberg Radio
Radio

LISTEN HERE (or click the graphic above): Bloomberg Markets with Robert Eisenbeis Ph.D.

If you like this podcast, you may enjoy the June 22, 2018 Bloomberg Daybreak interview with  David Kotok, Chairman and Chief Investment Officer at Cumberland Advisors. He discusses the Dow’s eight day drop and possible trade war with China. He also discussed bonds and treasuries with Bloomberg.

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


This podcast from 2015 features David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/