Top Fed Heads Now Seeing Tailwinds Rather Than Headwinds

The Fed: Governors in Sync. “Navigating Monetary Policy as Headwinds Shift to Tailwinds” was the title of Federal Reserve Governor Lael Brainard’s 3/6 speech. It was her first speech since Jerome Powell swore into his new role as Fed chair on February 13. Brainard and Powell aren’t new to working together, having served concurrently as Fed governors for nearly four years.

Recently, it appears that the two are tag-teaming on developing new lingo for Fed communications, as Powell used the headwinds-turning-into-tailwinds metaphor in his 2/27 testimony presenting the Semiannual Monetary Policy Report (MPR) to the Congress.

Powell and Brainard are both bullish on the US economy. However, both also continue to advocate for a “gradual” normalization of monetary policy. Both see room for improvement in labor force participation, especially given the numbers of prime working-aged people currently on the sidelines. Both remain unconcerned about inflation overheating despite the fiscal tailwinds that both expect to boost US economic growth.

Only in the nuances of inflationary trends do the Fed governors have a difference of opinion. But those nuances probably won’t make a difference for monetary policy-setting, at least in the near future.

Until the word “gradual” ceases to appear in Fed governors’ communications, we expect that will be the pace of federal funds rate hikes.

Consider the following:

(1) Laying low. Brainard believes that the theoretical inverse relationship between inflation and unemployment (a.k.a. the Phillips curve) has flattened in practice. She said: “While transitory factors” have “played a role,” core inflation has remained “stubbornly low” as a result of “persistent factors.” As Melissa and I discussed in our 3/5 Morning Briefing, Powell seems to put more weight on the transitory factors weighing on inflation than on the structural forces. Nevertheless, neither Brainard nor Powell is concerned about inflation overheating. Brainard said that “stronger tailwinds” may “re-anchor inflation expectations.” She added, however, that any “mild” overshoot that could occur would likely be temporary. Powell similarly said that he expects inflation to stabilize around 2%.

(2) Prime slack. Both Powell and Brainard suggested that discouraged prime-aged workers currently not in the labor force might rejoin it. “[T]he employment-to-population ratio for prime aged workers remains more than 1 percentage point below its pre-crisis level,” Brainard stated. But she added that “it is an open question as to what portion” of prime-aged workers not in the labor force may respond to tight labor market conditions. During the Q&A portion of Powell’s testimony, he cited the exact same employment-to-population statistic. Likewise, he stated that the amount of sidelined prime-aged workers who may come back into the labor force is unknown.

(3) Gradual pace. “Headwinds to tailwinds” might be the Fed’s new favored phrase. But use of the word “gradual” to characterize the pace of federal funds tightening has yet to be dropped. Powell said the word numerous times during his testimony. Brainard concluded: “Continued gradual increases in the federal funds rate are likely to remain appropriate to ensure inflation rises sustainably to our target and to sustain full employment.” Even so, she hedged by saying that recent tailwinds could take the weight off the “path of policy.”

(4) Tightening abroad. Brainard opened her talk focusing on “stronger economies abroad” as a tailwind for US exports and, thus, domestic multinationals. She also noted that US import prices have increased, driven by currency appreciation abroad resulting from the expectation of monetary policy tightening abroad. Sure enough, the European Central Bank dropped language relating to its commitment to increasing the size of its quantitative easing from its March 8 monetary policy statement (compared to its previous one), a few days after Brainard spoke. On March 1, a few days before Brainard’s speech, the Bank of Japan’s Kuroda said that the bank would probably start considering an exit strategy for monetary policy in 2019.

(5) Tariff murmurs. It will be interesting to see whether the recent White House trade developments influence monetary policy at all at home or abroad. During her 3/6 speech, Brainard said nothing of Trump’s March 1 aluminum and steel tariff announcement. During the March 1 MPR follow-up Q&A with the Senate, Powell hesitated to comment on the tariffs. But he did say, quoting prior Fed Chair Bernanke, that tariffs might not be the best approach to trade deals. Already, the Trump administration seems willing to negotiate tariff carve-outs for allies, including Japan and the European Union. Therefore, the tariffs may be irrelevant for policy-setting, at least for now.

US Economy: House of Money. There are some economists of the pessimistic persuasion who believe that America’s prosperity is built on a shaky foundation. They see our economy as a house of cards. Debbie and I see it as a house of money, built on the solid foundation of record-high real GDP, real incomes, and corporate earnings.

US consumers have never been wealthier than they are today. Granted, some are wealthier than others. However, practically everyone with a long-standing retirement plan, especially if it is a 401(k) plan, has some impressive capital gains in their stock portfolio. That’s true measuring performance not only since the start of the current bull market but also since the peak of the previous bull market. The same can be said about owners of real estate. The Fed’s Financial Accounts of the United States, updated through Q4-2017, was released on March 8. The net worth of Americans is truly impressive.

Let’s review the happy stats:

(1) Net worth. The net worth of the household sector rose to a record $98.7 trillion at the end of last year (Fig. 1). It is up $43.8 trillion since Q1-2009, when the latest bull market in stocks commenced. It exceeds the previous cycle’s peak during Q2-2007 by $31.0 trillion. The ratio of the household sector’s net worth to disposable personal income rose to a record 6.8 at the end of last year (Fig. 2).

This achievement was accomplished with less debt expansion than in the past (Fig. 3 and Fig. 4). The household sector’s assets are up 65.5% since Q1-2009, while the sector’s liabilities are 10.5% higher.

(2) Total assets. Households held total assets valued at $114.4 trillion at the end of last year. That total consisted of $80.4 trillion in financial assets and $34.0 trillion in nonfinancial assets (Fig. 5). Both were at record highs.

(3) Financial assets. The biggest component of households’ financial assets is pension entitlements, which rose to a record $23.2 trillion at the end of last year (Fig. 6). It includes public and private defined benefit and defined contribution pension plans and annuities, including those in IRAs and at life insurance companies. It excludes Social Security. This category has doubled since Q1-2004.

The second-biggest asset category in the Fed’s accounting for the balance sheet of the household sector is corporate equities directly held, at market value. It rose to a record $17.9 trillion at the end of last year. It includes closed-end funds and the shares of ETFs and REITs. Also making a new record high, at $11.6 trillion, was equity in noncorporate business. Another big item in the financial assets of households is mutual fund shares, which rose to a record $8.7 trillion at the end of last year.

(4) Nonfinancial assets. Real estate accounts for the bulk of assets held by households in nonfinancial assets. The value of homes rose to a record $24.5 trillion during Q4-2017, exceeding the previous cycles high during Q2-2006 by 8.0% (Fig. 7). The 12-month average of the median existing single-family home price dropped 26.6% from July 2006 through February 2012. It has rebounded 51.1% since then through January of this year. Real estate is highly leveraged in the US. As a result, owners’ equity—i.e., the value of household real estate minus home mortgages—plummeted 55.2% from Q1- 2006 through Q1-2009 (Fig. 8). It leveled out and finally started recovering at the start of 2013. It is up 84.2% since then.

The aggregate of owners’ equity fell below the value of home mortgages from Q4-2007 through Q3-2013. So on balance, the entire country was “underwater,” owing more on their homes than the equity they owned in their homes. The situation has improved since Q4-2013 with owners’ equity once again exceeding home mortgage loans outstanding. At the end of last year, homeowners collectively owned 58.8% of their homes, up from a record low of 36.2% during Q1-2009 and the best since Q1-2006 (Fig. 9).

(5) Liabilities. Despite the significant rebound in real estate values, home mortgage debt has been essentially flat since 2007 (Fig. 10). As a result, home mortgage debt as a percentage of total household liabilities has dropped from a record high of 74.9% during Q1-2009 to 64.4% at the end of last year, the lowest reading since Q4-1987 (Fig. 11). The ratio of home mortgage debt to disposable personal income has dropped from a record high of 1.00 during Q3-2007 to 0.69 at the end of last year, the lowest since Q1-2002 (Fig. 12).