Last week, the Fed Governor Lael Brainard gave a very interesting speech, suggesting that the week first quarter does not support an early interest rate hike. What can we learn from her speech on monetary policy?

Lael Brainard, the Fed Governor and a voting member of the Federal Open Market Committee, gave a speech entitled “The U.S. Economic Outlook and Implications for Monetary Policy” on June 2 at the Center for Strategic and International Studies, Washington, D.C.

The speech was interpreted as dovish, but it was just realistic, being a pleasant change after all those hurray-optimistic official statements and mainstream news. She agreed that bad weather, port disruptions and statistical noise can be responsible for some of the weakness in the first quarter, however she noticed that:

“But there may be reasons not to ignore the recent readings entirely. First, the limited data in hand pertaining to the second quarter do not suggest a significant bounceback in aggregate spending, which we would expect if all of the weakness in the first quarter were due to transitory factors. Private-sector forecasts of second-quarter growth are centered around 2-1/2 percent, while the Federal Reserve Bank of Atlanta's GDPNow forecast, which was quite accurate in its prediction of the first estimate of first-quarter GDP growth, is projecting second-quarter GDP growth of only 0.8 percent” (right now, after better than expected trade deficit data, the GDPNow is projecting 1.1 percent growth).

This is exactly what we have been saying all the time. Brainard also pointed out that the prevailing optimistic forecast resulted from placing “too much weight on the boost to spending from lower energy prices and too little weight on the negative implications for aggregate demand of the significant increase in the foreign exchange value of the dollar and large decline in the price of crude oil”. This is another thing we have been constantly warning against. The decline in oil price is definitely positive for U.S. consumers, however, it hit the energy sector hard, which had ballooned during the artificial bubble. I dread to think what would happen if the crude oil prices did not stabilize recently. As Brainard noticed, “in response to the drop in oil prices, drilling activity is reported to have fallen at an annual rate of nearly 50 percent in the first quarter, and data on drilling rigs in operation suggest another large decline this quarter”.

Why were the forecasts on consumer spending overly optimistic? The analysts predicted that consumers would spend much of the gains from cheaper prices at the pump, but “consumer spending so far this year has been undeniably weak, especially given a backdrop of improving labor market prospects, solid consumer sentiment, and improving credit availability. Consumer spending is reported to have increased at an annual rate of only 1.8 percent in the first quarter – far below the 5.3 percent increase in household real disposable income”. It should not be surprising, given the debt burden and the rising rental and medical costs. What the consumers saved on cheaper gasoline, they spent on housing, healthcare or just decided to strengthen their balance sheets by repaying some of their debts.

Brainard looked not only at recent data, but also at the long-term trend. Therefore, she was able to notice that “although the data on April housing starts and permits look promising, the current level of single-family housing permits is little changed from the level in the fourth quarter of last year, and average growth in residential investment over the past year and a half has been tepid. Given low interest rates and continued job gains, it is puzzling that housing starts have remained far below the trend levels implied by population growth”. Undoubtedly, it is not puzzling, given the sluggish wage growth, tight credit for borrowers and the debt burden.

Brainard also pointed out the weak indicators of business equipment spending, the slowdown in Chinese GDP growth, the fragile recovery in the Eurozone and the worries over Greece, the stronger dollar weighing on U.S. inflation, and so on. In consequence, she believes that “the string of soft data in the first quarter raises some questions about the contours of the outlook” and “the case for liftoff may not be immediate”.

Summing up, Brainard painted a surprisingly realistic economic picture in her speech. Finally, a Fed official noticed that the weakness in the first quarter was not solely caused by transitory factors, so there will be no significant rebound in the second quarter. Her dovish speech is a good indicator before the June FOMC meeting. It seems that recent data does not support any but only a symbolic hike later this year (according to the futures market, the June hike is off the table and the first possible date for an increase is October). It is positive news for the gold market, since the later and more gradual the hike will be, the better for the gold prices.

Thank you.

Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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