Washington Insider -- Wednesday

The Fed's Problem with Inflation

Here’s a quick monitor of Washington farm and trade policy issues from DTN’s well-placed observer.

Mixed Signals from Administration On Additional Ag Aid

The Trump administration appears ready to provide additional aid to farmers if required, National Economic Council (NEC) Director Larry Kudlow told reporters at the White House, according to Reuters.

"We have allocated $12 billion to farm assistance. And we stand ready to do more if necessary," Kudlow said.

However, USDA Secretary Sonny Perdue on Monday in Iowa said, "I am afraid that is not accurate," the Des Moines Register quoted Perdue as saying. "I think that possibly could be some miscommunication," he added. Perdue repeatedly has ruled out a new round of aid for 2019 crops and $8.3 billion has been paid out to date as part of last year's program.

On Monday, USDA said it had extended the deadline to apply for such aid to May 17, from May 1. Perdue also said that Trump has not talked with him about any additional trade aid.

"The president and I have not talked about that. Obviously, he was very forthcoming last year with $12 billion" in emergency federal emergency aid, Perdue said Monday, following a tour at Corteva Agriscience, the former Pioneer Hi-Bred seed giant based in Johnston, Iowa.

Mexican Legislature Approves New Labor Reforms

The Mexican legislature has approved changes to its labor laws, including granting workers the right to vote on unions and labor contracts via secret ballots. The legislation was called for under the U.S.-Mexico-Canada Agreement (USMCA).

"These reforms will greatly improve Mexico's system of labor justice and are exactly what labor leaders in the United States and Mexico have sought for decades,” US Trade Representative Robert Lighthizer said in response to the action. “As we move forward with the ratification of USMCA, the Trump administration will work closely with members of the United States Congress and the Mexican government to ensure these reforms are implemented and enforced.”

Democrats have said that labor law changes in Mexico are a key issue for them relative to whether or not they will back the trade deal.

Washington Insider: The Fed’s Problem With Inflation

Bloomberg is reporting this week that there is “a flaw at the heart of central banking’s approach to inflation targeting that’s become a hot issue for the Federal Reserve as it takes a long, hard look at its strategy.”

The report notes that for decades, central bankers have pursued price goals while saying financial stability risks are better curbed by regulation. The contradiction is that monetary policy is often the most powerful fuel for asset bubbles as central bankers hold interest rates low to try and lift inflation that remains weak despite solid growth and rising productivity.

That describes the U.S. today, Bloomberg says, with stocks trading at record highs and financial conditions easy. As central bankers meet this week they are seeing an economy growing strongly while the core inflation rate slowed to 1.6% last month--well below their 2% goal. It continues a persistent “undershoot” which has prompted a year-long review of the Fed’s price strategy.

“A big part of the policy rethink has to be making the costs and benefits of these trade offs more rigorous and explicit,” said Julia Coronado, founder of MacroPolicy Perspectives LLC in New York. “How much signal do they want to take from the turndown in core inflation given the growing leverage in the corporate sector that could make the next recession deeper?”

Central banks elsewhere have wrestled with striking that balance and the conflict resulted in the resignation in Sweden in 2013 of Riksbank Deputy Governor Lars EO Svensson. He stepped down after his colleagues ignored his calls for deeper rate cuts because they were worried about fueling unsustainable credit growth.

Just last month Fed officials were divided over whether to raise a capital buffer on the largest banks. They’ll include a panel on financial stability at a Chicago conference in June on the conduct of monetary policy.

“If financial conditions ease, growth will be higher and monetary policy should respond” with tighter policy, said former Fed Governor Laurence Meyer. Yet central banks’ response to financial risk is often a story of “not yet, not yet, not yet – too late!"

U.S. central bankers sound intent on getting inflation higher, after missing their target almost continually since adopting it in 2012. Officials worry that if they can’t hit 2% inflation amid strong growth and low unemployment they may never get there.

Such concern was reflected in the Fed’s pivot to keeping rates on hold this year, which has boosted financial assets, and tilted the flow of money toward riskier investments. Larry Fink, the chief executive officer of Blackrock Inc., the world’s largest asset manager, said in April that there is greater risk of a stock market “melt up" than meltdown.

Bloomberg says its economists maintain the view that the Fed tightening cycle is not yet finished, and that the case for incremental additional tightening should become more evident as the data continue to strengthen and financial conditions ease.

It also notes that, in general, economists expect the Fed to “ignore market froth,” leaving the policy rate on hold in a range of 2.25% to 2.5% at the conclusion of their current meeting – while expressing concern over “muted” inflation. It’s a tricky subject for the Fed to navigate without sending mixed signals to the markets.

New York Fed President John Williams, prior to the rate hike in December, said an increase had the “added benefit" of reducing financial imbalances. As stocks plunged after the move, Williams said the Fed is “listening very carefully to what’s happening in markets."

Fed officials discuss financial stability risks at most policy meetings. The Fed Board in Washington even publishes a semiannual report focused specifically on financial risks. But the committee’s communication on the topic can appear confusing and contradictory.

Minutes from the March 19-20 FOMC meeting show “a few” officials worried about growing financial stability risks and a couple pushed to trigger a requirement for big banks to build bigger capital buffers to guard against a downturn. Yet earlier that month the Board voted 4-1 not to do so, with Governor Lael Brainard dissenting.

“How much froth in leveraged lending is the Fed willing to tolerate in exchange for 20 basis points on inflation?" Coronado asked a New York Fed advisory panel earlier this month.

Fed Chairman Jerome Powell will likely face similar questions at his post-meeting press conference Wednesday. He told reporters last month that the linkage between monetary policy and financial stability is an “unsettled and difficult” question and the first option is regulation and supervision.

Fed officials are asking, “What is the alternative, what can we do?’’ said Seth Carpenter, a former adviser to the Fed Board who is now chief U.S. economist at UBS Securities LLC. Greenspan’s answer was, “Well that is just capitalism,” and that didn’t turn out very well, he said, referring to former Fed chief Alan Greenspan.

Greenspan was right that “ultra-fine tuning” the economy often doesn’t work out well. Thus, a great deal of attention is expected concerning the Fed’s upcoming deliberations—a process producers should watch closely as it proceeds, Washington Insider believes.

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