Don’t Blame Us. We’re Data Dependent
Over the last quarter century, there has been a revolutionary change in financial management. With the advent of the laptop and the internet, the ability to follow a given computer model has come. Walk into your local financial planner, and they will likely start up a program, ask you a series of questions, and produce an -ideal pre-planned investment program designed for people like you.
Invest in most mutual funds, Exchange Traded Funds, or Index Funds, and your money will automatically follow a given benchmark. The largest of all funds, Black Rock, manages most of its funds using a Computer Program called Aladdin.
The nation’s number one financial manager, the Federal Reserve, now bases many, if not most, of its decisions upon computer models. The models tell the Fed where the economy is currently and can project where future fed policy will lead us. GDP, Inflation, and Employment are all modeled before the Fed makes any decision. If the Fed raises interest rates to this level, inflation will fall to this level. It’s a preview of coming attractions.
All data-dependent.
It’s a trend I started following a few years ago when some friends and I created a drinking game called the “Data Dependent” game. How many times would a Chairperson of the Fed use the term “Data Dependent” in one of their significant addresses, like their testimony before Congress or an announcement of interest rates?
As it turns out, the more you hear “Data Dependent,” the more the Fed feels the pressure. The use of the double Ds began under Ben Bernanke, the Chairman of the Fed, in the early 2000s. I’m sure his predecessor, Alan Greenspan, used the term only occasionally. And for both Greenspan and Bernanke, my impression was that they only used the double Ds to sound up-to-date.
Under Janet Yellen, the use of “Data Dependent” became an art form. Partly because it puts the decision-making responsibility on a third party: “Data.” And partly, it reflected how the Fed was now operating. For Ms. Yellen, Data Dependent transformed from a simple method of collecting observations to the way decisions are made. When Yellen said the Fed is Data Dependent, it now meant that the Fed would follow the data where ever it might lead. Like those other financial management firms, the Fed now follows “data” exclusively.
How Data Dependent the Fed is, became crystal clear on CNBC the other day. Mohamed El-Erian was interviewed. And he made this emphatic point: When the Fed meets in three weeks, it will have to raise interest rates by 75 basis points. It has no choice.
Why? Because the Fed is now, you guessed it, “Data-Dependent.” And all the data is aligned to raise rates. The Fed has said it will raise rates if inflation continues to climb and employment is steady.
Both of those data points are in place now. Inflation is above target (2%). Unemployment just fell to 3.5%. Therefore, following the data, the Fed must raise rates.
I think El-Erian is 100% correct. He’s nailed it.
These are not subjective criteria. Congress mandates that the Fed is to maintain stable prices and full employment. And using these two measures, the unemployment rate and the Consumer Price Index, are a pretty good estimate of those two objectives.
Here’s the problem: the unemployment rate and the CPI are from September. These data points will be over a month old when the Fed meets to set interest rates on November 1st and 2nd. Further, unemployment is notoriously a lagging indicator. Businesses tend to wait until well after conditions change before either hiring or firing.
Today the Fed is trapped in its dependency on stale and lagging data.
Three weeks from today, the Fed will make the decisive interest rate decision that will take us through the end of the year. The December meeting will come too late to have any real impact on this year.
If El-Erian is correct, and I think he is, then we will see a final tightening of interest rates just as the holiday sales season gets underway and other companies wrap up their fiscal year. A slowing economy at this time would be disastrous.
But don’t blame the Fed. After all, they are just “Data-Dependent.”
NOTES
More troubling economic news out of Great Britain this morning. Analysts expected the British economy was flat in September. However, the economy declined by 3/10th%, much weaker than expected, the second decline in British GDP in the latest quarter and a clear indication that Britain may be slipping into recession.
Well, mortgage interest rates keep rising, so new mortgage applications keep falling. Yesterday the 30-year mortgage interest rate hit 6.81%, the highest mortgage rate in 16 years, more than double the 3.1% interest that home buyers were paying just a year ago. And the predictable result: new mortgage applications down an incredible 69% from last year.
Mortgage brokers are yelling “Uncle,” do you think the Federal Reserve can hear them?
Shortly we will get the first of two significant reports on Inflation. The Bureau of Labor Statistics will report the latest Producer Price Index in a couple of hours. Here is a measure of Inflation that’s been all over the board lately, declining in the last two months.
Gas is creating a toss-up in this report on Inflation at the wholesale level. The Producer Price Index has closely tracked the price of fuel and energy. And this could be a little tricky this month. After declining for three months and hitting a low of $3.65 a gallon, regular gasoline turned higher. Gas rose about 7% at the end of September.
Tomorrow we’ll get the latest Inflation report for you and me, the Consumer Price Index. And like Producer Prices, the CPI is most sensitive to gasoline prices, which, as I say, have been rising.
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