By Herb W. Morgan, III, Efficient Market Advisors
The United States economy and macro-economic science are evolving to a critical point that seems destined to change how monetary policy makers view their role and execute on their mandates. At the center of it all is the Phillips curve. The Phillips curve, which has fairly accurately predicted the relationship between employment and prices is on its way out as a policy tool, thanks to the longest economic expansion in U.S. history. This expansion now boasts the tightest labor market on record without the higher inflation called for by the Phillips curve.
The Phillips curve comes from W.H. Phillips’ study of the correlation of employment and inflation, which studied data in the U.K. from 1861 to 1957. The work was a major milestone for the dismal science. While widely accepted as a powerful policy tool, it has been challenged over the years by the likes of Milton Friedman and others. Today, the U.S. jobs expansion which has produced positive results since Q4-2010, is providing a hard data challenge to long established orthodoxy. Unemployment has plummeted by every conceivable measurement. Job openings in the U.S. far exceed the number of unemployed, yet the expansion continues without any measurable amount of systemic inflation.
It is hard to blame the Fed for sticking to the Phillips curve orthodoxy like it did through the end of 2018. After all, this was accepted economic science. The U.S. had reached full employment and it seemed logical that inflation would pick up. What surprises many Fed watchers now, is that just six months later the Fed itself seems poised to abandon the Phillips curve mentality in response to data that strongly indicates, things are different today. Inflation simply did not pick up even as the U.S. has maintained full employment for an extended period. Further, while the fed was becoming “less loose” by accelerating balance sheet runoff and raising the Fed Funds rate, U.S. Financial markets signaled further “less loose” moves by the Fed were unwarranted.
To be sure, the landmark Phillips study was done and subsequently followed, during a period of more insulated national economies. Today, central bank policies from the U.K., ECB, China, Japan and others can have a significant impact on inflation dynamics here in the United States. Measures of inflation by a consumer-oriented price index, sovereign break-evens, or the market price of a precious metal are now taking a back seat to measurements taken by the value of a currency relative to its competitors.
The relentless rise of the U.S. Dollar relative to other currencies, has now garnered the attention of the Fed as it carries out the price stability half of its dual mandate. The rising value of a currency displays a lack of inflation. It now appears the Fed is poised to cut rates in an attempt to lower the US dollar.
This article was contributed by:
Herb W. Morgan, III
Senior Managing Director &
Chief Investment Officer
Efficient Market Advisors, A Business Of Cantor Fitzgerald Investment Advisors
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