Calculated Risk

By Bill McBride

Special Note: This was mostly written prior to the failure of Silicon Valley Bank. Now it appears the Fed might pause in March. Goldman Sachs economists wrote last night: “we no longer expect the FOMC to deliver a rate hike at its next meeting on March 22 (vs. our previous expectation of a 25bp hike)”, although BofA economists wrote this morning “After the latest developments around Silicon Valley Bank and the Fed, we retain our outlook for a 25bp hike in March.”

In Part 1 of Pandemic Economics, Housing and Monetary Policy I noted that pandemic economic outcomes were frequently largely unexpected. And that this has been especially true for housing.

Housing is the key transmission mechanism for monetary policy. And we need to be on the lookout for pandemic distortions to normal economic patterns – especially in housing – and hope that the Federal Open Market Committee (FOMC) will adjust monetary policy accordingly.

Many analysts are puzzled about why the economy hasn’t slowed quicker given the rapid increase in the Fed Funds rate over the last year. Some analysts are even concerned about “premature reacceleration”. Goldman Sachs economists wrote last week:

“In recent months we have argued that the drag on GDP growth from last year’s fiscal and monetary policy tightening is fading, not growing, and that this means that the key risk for the economy is a premature reacceleration, not an imminent recession.”

emphasis added

When I read some of the recent comments from FOMC members, I’m reminded of a great scene from the movie China Syndrome where a stuck indicator almost led to catastrophic failure. From the China Syndrome script:

High water level in the reactor!

Okay, relax. Everybody relax. Dump the water.

It’s just a routine turbine trip.

Find out where that water’s coming from. We’ve got to get rid of it.

…

Jack! Look at this water level indicator. It’s low.

This says it’s high. But that’s … Jesus Christ! Barney, give me feedwater.

Ted, we may uncover the core.

Operations.

Jack Godell. We have an emergency. Get everybody into safety areas.

Some FOMC members are shouting “high level water in the reactor” (Fed Funds rate too low). They keep turning the knob and wondering why nothing is happening. But perhaps the indicator is stuck, and after adjusting for pandemic distortions, the water level may already be OK.

A key question: the FOMC claims to be “data dependent”, but are they appropriately adjusting the data for pandemic economic distortions?…