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Rates, Rates, and More Rates - November 27, 2018

Maximum Employment and Riskless Real

As the December FOMC looms in the distance, a number of Fed members, both voting and non-voting, have been out recently emphasizing “data dependence”. Dallas Fed’s Kaplan highlighted this concept in an interview on Fox Business, explaining, “that means we’re going to be very sensitive, to talking to contacts, looking at data, understanding what’s going on with businesses, looking global.” Yesterday, Vice Chairman Clarida gave a speech, “Data Dependence and U.S. Monetary Policy”, discussing how in practice data dependence means taking in new data and then updating estimates of “the two most important unknown parameters... the rate of unemployment consistent with maximum employment u* and the riskless real rate of interest consistent with price stability, r*”. FOMC participants keep revising their estimates of u* and r* lower as inflation, and inflation expectations, have not risen despite low unemployment and low real rates over the past few years. Clarida ended his speech by saying that this learning and revision process “supports the case for gradual policy normalization”, and we will see if Powell has anything further to add during his speech tomorrow.

 Unemployment and Participation

One of the explanation’s given for why inflation and wage growth haven’t picked up with low unemployment is labor market slack. As covered in a Reuters article, Minneapolis Fed President Neel Kashkari, one of the more vocal proponents of this idea, believes there “is more slack in the labor market” during his talk at the Minnesota Ag and Food Summit. However, a recent article from the San Francisco Fed disagrees with this idea. Wage growth aside, the paper constructs an adjusted estimate of the Labor Force Participation rate by considering demographics and finds that participation is at trend. “Combined with the low unemployment rate, this argues that the U.S. labor market is operating at or beyond its full potential”, the article said.

 Mortgage and Housing Price Growth

 Finally, the data out today shows that home prices are still growing year on year, but at a slower rate, and the cost of financing was again appointed as a problem. As covered in an article from Housing Wire, S&P’s David Blitzer pointed to mortgages as a contributing factor in the weaker housing markets. “Currently the national average for a 30-year fixed rate loan is 4.9%, a full percentage point higher than a year ago,” Blitzer said. And while it would seem to be a good thing that new home sizes are decreasing as builders move to entry-level construction, Robert Dietz writes that “typical new home size falls prior to, and during, a recession as home buyers tighten budgets”. But is not too gloomy as the current dynamics may just be a decrease in the proportion of high-end homebuyers and a cooling of the custom market.