Take Cover From the Storm...the Fed Will

Take Cover From the Storm...the Fed Will

A GDP Bob and Weave

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The human tragedy that played out in Texas during the first last week of August is being repeated this week in Florida. Hurricane Irma struck land on the west coast of Florida shortly after Hurricane Harvey struck the Texas Gulf Coast near Houston, and hurricane season is not over. As human beings, our job is to provide as much help as we can to the victims of these storms through donations (if you can), prayers (if you pray) and physically help whenever possible. As traders, our job is to figure out what the effect of these storms will have on markets and economies and they will have an effect.

We already saw jobless claims jump by 62K, which was attributed to Harvey. In a research note on Thursday Gus Faucher, chief economist and senior vice president at The PNC Financial Services Group wrote in "The one-week jump in claims of 62,000 was the biggest since an increase of 81,000 in November 2012 in the wake of Superstorm Sandy." He included "claims jumped by 96,000 in the week after Hurricane Katrina in September 2005."  Clearly, storms of the magnitude of the ones mentioned above steal economic activity from the future, changing the trajectory of both jobs and GDP in the short to medium term. How much of a change is dependent upon the extent of the damage. Texas governor Greg Abbott estimates the damage to be $180 Billion, which is almost one percent of the nation's GDP. Early damage estimates from Irma have been as $300 billion. Another 1.6% of GDP. Now, this is not to say that those losses will come off the next batch of GDP numbers, this is just for context. Most experts say Harvey will shave one-tenth of one percent off of Q3 GDP and by that logic, Irma will cut another two-tenths, but that growth is borrowed and will coming back, bringing more growth along with it. So how does this play into the FOMC decisions on balance sheet normalization and future rate hikes?  

Referring to the storms, New York Fed President Bill Dudley told CNBC in an interview that “it’s possible they could have an effect on the timing of short-term rate increases. But I think that’s probably further out anyway.” Did he mean rate hikes are further out or the effects of the hurricanes are further out? “The long-run effect of these disasters, unfortunately, is it actually lifts economic activity because you have to rebuild all the things that have been damaged by the storms,” he continued, pointing out the added GDP we mentioned. Mr. Dudley was letting us know that while people were seeking cover from the storms, the Fed will be seeking cover in the storms. 

The GDP bob and weave that we are about to see gives the FOMC several options to deal with the fact that US data has been just OK. Fed watchers still expect one more rate hike this year, but fed funds futures do not have it priced in. Nowhere on the futures curve is the probability of a rate hike any higher than a 37.5% chance, going all the way out to mid-2018. The Feds own "dot plots" have the median fed funds target rate in at 3% by Q2 of 2018 while the market has it priced in at 1.5%. So what can they do if they want to get rates up? They blame further weak data on the storms and speak to needed to hike rates before a GDP pop from the same storms causes runaway inflation. 

Another game plan would be to start telegraphing to the markets that rates need to stay lower despite the "strong" economy in order to facilitate the storm-driven rebuilds. This is unlikely, but never under estimates the Fed's ability to explain away policy. In that arena, they can be as unpredictable as the path of a hurricane. 

Note: it's difficult writing this while people are suffering. I do pray...and my prayers are with those affected by these storms. 


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