Desperately Reading the Fed

There has been some desperate hunting last week for getting a sense of the Federal Open Market Committee's (FOMC's) view on whether the Federal Reserve would make a move to raise interest rates--to return to "normal." On Monday, Federal Reserve Governor Lael Brainard suggested she did not see a need for a timetable to raise the rate this year and, instead, that policy changes should continue to be on the basis of the data at hand. Actually, while this was treated as new, and some suggested she "rarely speaks publicly, " Governor Brainard said very similar things back in June . She was followed the next day with comments on CNBC from Federal Reserve Governor Daniel Tarullo, who was suggesting a similar sentiment.

The confusion is because after the September FOMC meeting, where Federal Reserve Chair Janet Yellen pointed to international uncertainties that could be headwinds for the U.S. economy , she gave a speech insisting the Fed was still on course to raise rates this year . Since her speech at the University of Massachusetts, the U.S. Bureau of Labor Statistics issued data for the September labor market. It was the worst labor market in more than a year. And the three month hiring trend is definitely slower than at the beginning of the year.

In fact, as time goes on, the case by those suggesting the Fed must act now before inflationary pressures kill off the economy grows weaker. This expansion is now in its 76th month. The average economic expansion of the post World War II era is 58 months. This now ranks as the fourth longest expansion, behind the expansions of the 1990s, the 1960s and the 1980s. The current string of 60 straight months of job growth is already one year longer than the record. If anything, the risk now is that the expansion is more likely to peter out or to succumb to a shock that rattles the assumptions of investors that fuel the current expansion.

There are two reasons why the current accommodative stance by the Fed is still needed at this stage of the recovery. The first is that this expansion long has been hampered by headwinds from an inadequate fiscal policy response. The Republican Congress has warred with President Barack Obama and stood as a stone wall in front of every effort to use fiscal policy to restore public investment in transportation infrastructure or the skills of America's children that would have boosted job growth. In the 14 quarters under the Republican Congress, the federal government has been a drag on quarterly GDP in all but three. Their shutdown of the federal government in 2013 and its concomitant disruption of the federal procurement process cuts points off growth. The insistence of Republicans to concentrate on deficit reduction removes some of the concern the Fed normally would have during an expansion; which is typically fueled by rising federal borrowing, not the greatest decline in the deficit since the end of World War II.

The second reason is that the Fed must normally step in with higher rates to help raise the value of the dollar and slow import demand and dampen inflationary pressures that way. Except, as the FOMC statement from September pointed out, the dollar is already strong. Part of the dollar's strength has resulted in less pressure on oil prices--which are globally denominated in U.S. dollars. But the strong dollar also has meant slower import demand. And it has meant slower demand for U.S. manufactured goods. These are all the results of the relative strength of the U.S. economy compared to the rest of the world. But,m weak world demand is a head wind for a recovery that was fueled in part by a recovery in U.S. manufacturing.

The more serious challenge at what must be considered the late stages of an expansion is that household incomes have not recovered. Once again, an expansion has been helped by consumer debt--this time in replacing the aging automobile fleet out on our aging roads, and private borrowing to invest in our children's education to offset the Republican refusal at the state and federal level to restore public education funding. This means we cannot afford slower income growth. We need faster income growth so these high-debt levels can be paid off.

There is a real asymmetry in Fed policy making. A hike in short-term interest rates would quickly translate into higher auto loan rates, which would slow auto demand and possibly be the shock to the system that forces this expansion to collapse. It isn't so simple for the Fed to reverse course and try to get the auto industry resuscitated. A flood of auto repossessions would flood the auto market with new model used cars that would take a long time to clear and leave many auto buyers with damaged credit records unable to finance their way back to car ownership.

Let's hope the Fed is looking at the data at hand. If anything, time is more likely running out on this expansion than running out on when the Fed would need to stop runaway inflation.