Fedwatching: Logan on the outlook (Jan 18 2023)
Some of you may know that my old boss from the New York Fed, Lorie Logan, recently became the new president of the Dallas Fed. Logan will be a voting member of the Federal Open Market Committee (FOMC), the body that sets the U.S. benchmark interest rate, in 2023. She gave her first big monetary policy speech today at UT Austin, which I attended. Since inflation and interest rates are top of mind for everyone these days, I figured I’d share my impressions of Logan’s speech with folks.
TL;DR – I think Logan will vote to raise rates by 0.25% at the next meeting (Feb 1). Overall, her tone struck me as mildly hawkish. She wants to continue hiking but do so slowly.
Here are a few more notes on portions of the speech that stood out to me:
Inflation
· Inflation is top of mind—PCE, the measure of inflation the Fed uses, has been 5.8% over the last two years and far in excess of the Fed’s statutory mandate of 2%... my impression is that her bottom line is that the Fed has to tighten (but slowly) until there’s clear evidence we’re heading back to 2%
· Logan broke current inflation down into 4 pieces in her speech—energy, housing, goods, and services. In a nutshell, she’s worried about services inflation but not the other 3.
· She talked about spikes in rent and home prices—highlighting the spike in Austin in particular (did I buy at the peak? Yuck) but noted that home prices are starting to cool down in response to higher mortgage rates. She thinks this cooling will be reflected in housing-related components of inflation coming down over the next 18 months and is “confident that relief will come.”
o I’m not so sure. I was helping my cousin look at places in Austin this weekend and prices look higher than when I bought in May 2021, but Austin is kind of wack so who knows. Or maybe prices will come down, but sellers haven’t budged yet and the market has yet to find its new equilibrium.
Employment
· The core part of her argument is that tightness in the labor market (she described it as “unsustainable”) is driving services inflation. She pointed out that wages have been growing 5% annually but productivity has only increased by 1.25% over the past decade or so. That implies that wage growth needs to come down ~2% annually in order to get 2% inflation.
· That said, she did caveat this point with data showing that the labor market is slowing, and anecdotally that business contacts have told her they plan to slow hiring. But overall she’s a skeptic of the slowing labor market argument and “need[s] to see a lot more data, though, to be convinced that the labor market is no longer overheated”
· All of this points to the Fed continuing to tighten in order to reduce labor demand, a point she stated explicitly in her speech.
· She did talk about structural constraints on labor supply in her speech—excess deaths from COVID, early retirements, skills mismatches, and so on. I found this part confusing because she also mentioned the boom in net migration in Texas, but we seem to still have labor shortages here? I guess the labor supply picture is too muddled for her, or that addressing labor supply is too far outside of the Fed’s mandate or has too long of a lag, that the main lever to pull is reducing labor demand by slowing the economy.
The rate path
· Lorie used an analogy of going on a road trip and suddenly hitting a patch of fog with reduced visibility. She said that in that case, you would certainly slow down to be safe but you wouldn’t suddenly cancel the road trip or turn around and go home. My read is that although right now she thinks the data are pretty clear that services inflation is too high because the labor market is too tight, which means that we clearly should be continuing to raise rates, she has a gut feeling that the picture is going to become muddy pretty fast.
The Fed’s balance sheet and QE
I thought her comments on the balance sheet were really interesting, but this is some pretty nerdy Fed stuff so feel free to skip. My interpretations:
· She wants the size of the balance sheet to reflect the economy’s need for Fed liabilities (bank reserves and currency)
o Yes! This makes a lot of sense to me
· I thought this part was really important: if we see “modest” pressures in money markets as a result of balance sheet reduction, Logan won’t interpret it as a sign of scarce liquidity. This means to me that at least Logan won’t panic if say, we see the spread between Fed Funds and AAA commercial paper yields increase by 20 bps or whatever. (People on Zerohedge will panic, though.)
· Overall though she isn’t going to let ripples in money markets change her mind on the current path of tightening through the balance sheet—the bar is high and this part is mildly hawkish to me. We’d have to see something get messed up pretty bad for her to reverse course on asset purchases/QE