Streetwise for Friday, February 22, 2019

The late Madame Marie of Asbury Park would have tried to convince you that tarot cards and tea leaves provided a degree of insight into the future of all things, including the stock market. Personally, for the stock market I would suggest you use data related to the health of the economy instead. 

While not perfectly correlated, the economy and the financial markets are intertwined, meaning the economy’s cyclic behavior will play a key role in determining a successful investment strategy. 

Data regarding the economy’s health is not hard to obtain. We are continually bombarded with a prodigious stream of economic data and statistics. The problem is distilling out the salient information. To that end, you want to keep in mind the four key attributes of any financial or economic indicator: relevancy, timeliness, availability and stability.

Investors often utilize so-called “expert opinion” to capsulize information. However, it should come as no surprise that many experts potentially have a self-serving motive as they understand where their employers’ profits are coming from.

Government economists are in a similar position. They are charged with advising an administration on economic matters. Should they then be faulted for defending the administration’s resulting economic programs and policies?

Meanwhile, the Fed says clear communication is critical as it helps the public better understand the Fed’s position. The minutes of January’s Fed meeting indicated that a few participants expressed concern that amid increased uncertainty, policy rate projections in the Summary of Economic Projections “do not accurately convey the Committee’s policy outlook.”

And when the Fed meets next in March, it may be tough to tell a cogent story as the Fed’s two main tools will likely be in rare conflict. Specifically, the latest quarterly set of economic projections, including the so called ‘dots’ representing policymakers’ rate forecasts, is likely to show the Feds still expect to raise rates this year. 

At the same time, the official policy statement that will come at the end of the meeting will likely offer little in the way of interest rate direction. That could stoke fresh confusion over the Fed’s direction, despite Chairman Jerome Powell’s struggles to provide a consistent message.

To see how things might get confusing, consider that the most widely watched indicator for measuring inflation is the Consumer Price Index (CPI). Every month the Labor Department samples the prices of items that make up a representative basket of goods. A change in the prices of these goods will move the index up or down.

The Labor Department recently reported that the CPI was unchanged for a third straight month in January, leading to the smallest annual increase in inflation in more than 1-1/2 years. This in turn could direct the Fed to hold interest rates unchanged for some period.

Little discussed was that keeping the public confident that inflation will remain under control is critical to keeping inflation contained. A recent paper by the San Francisco Fed concluded that the rate of unemployment is all but irrelevant to the trajectory of inflation. Research of that nature could be important to the Fed’s thinking on interest rates. 

The paper’s researchers tested what would happen to inflation if the level of sustainable unemployment was 2 percentage points higher than currently thought, or if there were a lot less slack in the labor market than currently estimated.

The result was minimal shift in the inflation’s rate of change. However, when the researchers modeled what would happen if inflation expectations were to rise, they found that so too would actual inflation.

“Inflation dynamics today are primarily explained, not by economic slack, but by the public’s expectations that monetary policy will keep inflation close to the Federal Reserve’s target,” the researchers wrote. “Giving people a reason to doubt the central bank’s commitment to maintaining inflation near target is clearly costly.”

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.