The title of this post should probably be “The Fed’s Latest Mistake”, but that would be too preachy, so let’s just focus on the most recent slice of the mistake cake. The FOMC’s recent rate hike seemed to be much more about doing what they said they would do, than it was about data. After 2 years of delaying rate hikes by saying they were “data dependent” they raised rates in the face of the weakest CPI headline figures since May of 2015. It’s not just CPI, though, there are other factors that seem to say yellow light, not green light.
Take for instance the price of crude oil, which has now fallen into bear market territory down over 20% from it’s recent highs. It’s not just lower gas prices that come from cheap oil. Crude oil is a large input cost in agriculture, plastics, chemicals and healthcare, so along with competition, cheaper oil will push prices down in those industries as well. There is not much wage growth yet, and the highest input of prices at the consumer level is cost of wages. According to the Atlanta Fed’s wage growth tracker, wage growth is 3.4%.
That’s the same level as April 2016, except back then it was climbing, not falling as it seems to be doing now (from 3.9% in November 2016). Wages are in a flat uptrend, but could go either way in the short-term.
Then there’s the 2’s 10’s yield spread. This is the difference between the yield on the US 10 year note and the yield on the US 2 year note. Without going into too much detail, the wider the spread, the better investor feel about the long term prospects for the economy. The more narrow the spread, the worse investors feel. Currently, it is 80 basis points, back to where it was in September 2016, after having widened to 134 basis points in late December of 2016.
Add into the mix the plan to reduce the Fed’s $4.4 trillion balance sheet and you have a potential big mistake playing out. They think the weakness in data is temporary and history has shown that Q1 can be much weaker than Q2-Q3-Q4, but if it’s not, then this stick to the plan mentality could be the largest slice of mistake cake yet.