The Market Today

Fed Announces Shift to Average Inflation Targeting, With Implementation Specifics Still to Come

by Craig Dismuke, Dudley Carter

CORONAVIRUS UPDATE (VS Coronavirus Chartbook – PDF)

Monitoring the Virus Headlines: While the U.S. outbreak appears to have eased in recent weeks, the pace of the virus’s spread across Europe has picked up. Tracking those developments, Italy’s 1,411 new cases were in line with Wednesday’s report but updates from Spain and France were more concerning. Spain announced 3,781 new infections, the most in four months, while France reported 6,111 new cases, its second-highest single-day tally during the pandemic. Reflecting the concerns that has created, Germany’s Merkel asked citizens not to travel to high-risk areas and Denmark issued an advisory against unnecessary travel to France. Back in the U.S., the biggest COVID-19 news was a reported deal between the White House and Abbott Laboratories for 150MM additional tests. Yesterday after markets closed, the company announced its $5, 15-minute test had been approved for use in the U.S. The company’s shares rose nearly 8% on Thursday.



Income and Spending Beat Expectations as People Return to Work and Mobility Improves: Personal income and spending both beat expectations in July, rising 0.4% and 1.9%, respectively. Personal income increased on a 1.3% ($149.9B ann.) recovery of compensation income which offset the smaller decline in government stimulus.  Government transfers dropped 1.7% ($84.1B ann.) on a $105.5 billion decline in unemployment insurance payments.  Other government transfers, the category through which the one-time stimulus checks flowed,  were virtually unchanged in July for the first time in four months as the one-time payments have now run their course.  On the spending side, consumer outlays rose 1.92% ($267.8B ann.) as mobility continued to return.  After peaking in February, declining 19% in two months, spending has now regained 76% of the lost activity.  With spending outpacing income in July, the savings rate dropped from 19.2% to 17.8% but remained extremely high.

Goods Trade Remains Volatile in July: The July advanced goods trade balance showed another month of volatility with a large increase in the goods trade deficit, up $8.7 billion to $79.3 billion.  The trade data remain very volatile and the first look at 3Q figures point to a larger-than-expected drag on GDP.

PCE Inflation Remains Below Fed’s Target: The July PCE inflation data were a bit softer than expected but prior-month revisions brought the year-over-year rates up more than expected.  Both headline and core PCE inflation rose 0.3%, both below expectations.  However, headline rose from 0.9% to 1.0% year-over-year and core rose from 1.1% to 1.3%.  Inflation remains well  below the Fed’s target.

Consumer Confidence Revision: At 9:00 a.m. CT, the final report in a busy week of economic data will be the University of Michigan’s final revision to consumer confidence in August.  Confidence in both the U.M. and Conference Board reports has faltered in July and August.


Fed’s Framework Shift Sent Longer Yields Shooting Higher: Stocks gained Thursday and longer yields were jolted higher after the Fed formalized a shift in policy which officially endorses its projections to keep the target fed funds range near zero for the foreseeable future. As Powell kicked off his virtual “Jackson Hole” speech, the Federal Reserve issued a press release announcing updates to its formalized policy document which “articulates its approach to monetary policy and serves as the foundation for its policy actions” (more below). The Fed’s willingness to allow inflation to run above 2% after a period of below-target readings solidifies expectations for policymakers to keep shorter rates lower for longer to allow the labor market to tighten until inflation pressures become more clearly evident. The fed funds futures market ended pricing in rates at zero through at least the summer of 2023.

Steeper Curve Supports Financial Stocks Which Hand S&P 500 Another Record: With the Fed’s openly acknowledging it desires inflation above 2%, the requisite looser policy led to a bear-steepening of the yield curve throughout the session. While the 2-year yield edged higher, the 5-year yield rose 3.3 bps to 0.313%. The 10-year yield jumped 6.4 bps to 0.75%, its second-largest daily increase since early June, while the 30-year yield spiked 9.7 bps to 1.51%, the biggest jump since June 4. The 2-year/10-year spread widened to 59 bps and the 5-year/30-year spread expanded to 119 bps, both the steepest since early June. That fueled a rally in financial stocks which led the S&P 500 up 0.2% and to a fifth consecutive record close. The gains were capped by losses in momentum stocks and comments from Republican and Democrat leaders signaling stimulus negotiations remain stalled.


Markets Mostly Mixed After Fed Decision While Japanese Assets Respond to Abe’s Surprise Resignation: Global stocks were mixed Friday as investors continued to digest yesterday’s Fed announcement of a policy shift while stocks in Japan slipped and the yen rallied after the country’s prime minister resigned unexpectedly. Japan’s Nikkei tumbled 1.4% overnight and the yen jumped more than 1% after Prime Minister Abe confirmed earlier reports that he was resigning to again deal with his chronic issue of ulcerative colitis. As Japan’s longest-serving leader, he implemented extreme economic policies, ultimately coined “Abenomics,” to stave off deflation and boost growth. Elsewhere, Asian stocks excluding Japan inched up 0.2% while Europe’s Stoxx 600 dipped 0.2%. Despite the mixed global moves and before the morning influx of U.S. economic reports, U.S. futures were pointing to more gains for the Dow and another record for the S&P 500. At 7:22 a.m. CT, most Treasury maturities had trimmed a portion of yesterday’s steep yield increases. The 2-year yield was 1.2 bps lower, the 10-year yield was 1.5 bps lower, and the 30-year yield remained unchanged after yesterday’s spike.


Fed Shifts to Flexible Average Inflation Targeting: The Fed released a unanimously-approved Statement on Longer-Run Goals and Monetary Policy Strategy in coordination with Fed Chair Powell’s speech at the annual Jackson Hole Symposium. While the move was well anticipated, it arrived earlier than most expected. The policy document, which explains the Fed’s actions and was adopted in 2012, was revised to reflect framework changes resulting from a year-and-a-half long review of how the Fed approaches its inflation and employment mandates. Due to a move lower in interest rates and longer-run growth expectations in recent years and a looser relationship between unemployment and inflation, the Fed announced that it was adopting an average-inflation-targeting policy. Because there is no formula behind the new approach, Powell said it “could be viewed as a flexible form of average inflation targeting.” With this new framework, the Fed will “seek to achieve inflation that averages 2 percent over time,” meaning that “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” Powell clarified overshoots of the target will be “moderate,” not large, and allowed for “some time,” not permanent. Powell indicated that the Fed will not set an unemployment rate target but will use its tools to promote a strong job market. Bottom Line: Given this clearly dovish change, the Fed would be justified in easing policy further to address the long-running shortfall in inflation.  Moreover, the September Summary of Economic Projections becomes even more intriguing.

Pending Home Sales Signaled Housing Recovery Remains Afoot: Consistent with other sector reports released in recent days, the pending home sales report from the National Association of Realtors beat expectations in July. Following gains of 44.3% and 15.8% in May and June, July’s 5.9% gain exceeded the 2.0% improvement economists expected and pushed the index up to its highest level since 2005. By almost every activity metric, the housing market has finished a v-shaped recovery from the pain inflected amid the economic shutdown. The continued improvement, which was fueled by another month of gains for all four regions, bodes well for existing home sales in the months ahead.

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