I am asking you to put aside all your notions about monetary policy for a moment, and think about the next couple of points with an open mind. Forget about scary Central Bank balance sheets. Fight the urge to worry about the unprecedented quantitative easing programs. Dismiss the warning cries of the frightening levels of debt. Ignore the apocalyptic forecasts of coming stock market crashes. Let’s just have a look at the data. And most of all, let’s not worry about what should be done, but think about what will be done.
Rightly or wrongly, the Federal Reserve has a dual mandate. They are tasked with maximizing employment and maintaining price stability. Although many will debate what constitutes price stability, the Federal Reserve has interpreted it as a 2% inflation rate. You might think this absurd, so be it. It is what it is. Complaining will get you about as far as yelling at clouds.
When Janet Yellen took the reins of the Federal Reserve, many pundits predicted a period of exceptionally easy monetary policy as she was widely viewed as a uber dove. But has her reputation proved deserved?
The Fed’s preferred inflation gauge is the PCE Core Index. Don’t forget the 2% rate is a target over the long run. So if the Fed was meeting their objective, we should see half the observations above 2%, with the other half below 2%. Just for kicks, I put together a histogram of the PCE YoY% rate since Yellen took over.
Some dove. Yellen has consistently undershot her inflation mandate. Contrary to what most believe, Janet has been one of the most hawkish Central Bankers out there.
Why then does everyone think she is so dovish? Too many are focused on the Phillips Curve and are convinced the low employment rate will usher in higher inflation rates.
If you are a Phillips Curve disciple, it seems like the Federal Reserve is way behind the curve, and that Janet Yellen is being irresponsibly easy. When combined with the low nominal rates and the elevated Fed balance sheet, it is easy to fret about the fact that Janet is not raising quickly enough.
Yet what is the market telling us? The US Treasury yield curve has been flattening ever since Yellen took over.
The bond market is speaking, but most aren’t listening. It is telling us that Yellen is tightening too quickly. Or at least, she is by no means anywhere near as easy as the popular narrative.
Could it be that the bond market understands labour dynamics better than the supposed labour expert Janet Yellen? The Phillips Curve was at best a dubious rule, but in the current environment, it is next to useless. Does anyone really believe the government statistic of a 4.3% unemployment rate?
Here is a great chart from Meridian Macro Research that shows the employment-population ratio versus the unemployment rate.
So let’s think about the current situation. We have a perceived dovish Fed Chairperson who has failed miserably to achieve her inflation target, and although the other half of her mandate appears on the surface to be bumping against constraints, the idea that she has maximized employment is laughable. As she tightens, the bond market smells the coming slowdown (recession?) and flattens the yield curve.
I know this flies in direct opposition to the common belief that Yellen is a super dove who is way behind the curve. But if you take a step back and look at her record, it is a difficult case to make. She is undershooting her inflation mandate by a wide margin.
Now you might believe that target ridiculous, and Yellen should immediately crank rates to return monetary policy to sane levels. Yeah, I understand that argument, but it’s not relevant. The Fed is not about to change its stated goal (unless to raise their inflation target). I suggest you forget your complaints, and go back to yelling at kids to get off your lawn. I am just going to accept the Federal Reserve as another Central Bank that will inevitably debase our hard earned money. And the next big surprise will not be Janet becoming even more hawkish, but instead, Yellen living up to her reputation as an uber dove.
Thanks for reading,