Fed likely to keep tightening

U.S. jobless claims remain historically low, with no sign of an uptrend.  The implication:  Employment growth remains more than strong enough to keep the already low unemployment rate trending down.  Survey data generally remain strong as well.  The Fed has been tightening, but financial conditions continue to look accommodative.  Credit spreads are near their lows.

Inflation and wage gains remain tame, but they have been edging up, consistent with the NAIRU—non-accelerating inflation rate of unemployment—framework.  Based on that framework, more acceleration is likely as the unemployment rate keeps falling.

Against that backdrop, how close is Fed policy to being neutral?  Will there be a pause soon?  To what extent will officials’ actions be influenced by the threats coming from trade policy and the Mueller investigation?  How tolerant will Fed officials be if inflation keeps edging up?  What about yield curve flattening?  Will this Fed tightening cycle culminate in a “soft landing” or a recession?

We believe monetary policy is still quite accommodative, and that officials will ultimately have to go beyond neutral to stop inflation from continuing to drift up.  We are assuming that neither the president’s trade warmongering nor his legal troubles will become major drags on growth, although we realize that it is not our view that will ultimately be critical.  Rather, the impact on sentiment in financial markets and business and consumer confidence broadly will be key.  From that perspective, the threats have largely been taken in stride thus far.

The bottom line:  We continue to forecast no let-up from the Fed’s quarter-point-per-quarter tightening pace any time soon.  We continue to project a 3.4% level for the funds rate by the end of 2019, above the 2.6% level implied by fed funds futures contracts and the 3.1% median Fed official estimate—from the dot plot.  We expect bond yields will start moving up again soon as well, so we don’t believe an inversion of the yield curve is imminent. 

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