Disconnect widens between Main Street and Wall Street

Wages

Not till we see some decent recovery in a broad mix of labour data are we going to need to ratchet forward expectations for when the Fed actually hikes rates. Given that wages haven’t just been stagnant for quarters, or even years but by some measures decades, you can see why this stance gives investors hope that the good times for risk assets can continue. Now for the potential sting in the tail. The Fed is less afraid of deflation, if not yet expressing concern about inflation. “The likelihood of inflation running persistently below 2 per cent has diminished somewhat,” according to the statement, a view in line with recent upticks in some prices. “The bottom-line is that the Fed are giving strong indications for the first time that they are moving towards hitting both targets,” Steven Englander, foreign exchange strategist at Citigroup, said. “This does not mean that policy has to become hawkish overnight, but the motivation for keeping real and nominal interest rates at such extraordinarily low levels has eroded and that is what is new in the statement.” Combine that with the new information from second-quarter GDP report about one key measure of inflation actually running ahead of the Fed’s 2 per cent target and we might have a slight problem. That doesn’t mean we’ll get a Fed trying to play catch-up to inflation, in fact it seems unlikely, but we are closer on at least one measure to territory in which hawkish arguments resonate. One area unlikely to upset expectations for when a rate hike comes is GDP data, which showed a 4 per cent growth rate in the second quarter and a revised and improved 2.1 per cent fall in the first quarter.

Inventory

The headline figures were healthy but much of the recovery was a build in inventory. Inventory stocking accounted for 1.66 of the four percentage points of growth, but for that to be truly meaningful those inventories will need to be bought. And while there was a nice bump in business investment, a goodly portion of the auto sales that goosed growth were likely subprime-loan-enabled car purchases, a source which won’t fill policymakers with confidence. Bottom-line, the GDP numbers showed an economy continuing to slouch along rather than one accelerating towards wage growth. My guess is that the Fed probably wishes that financial markets would react differently to what it is saying. It would be far more convenient, for them, if interest rates backed up quite a bit in coming months, setting the stage for a rate hike in 2015 without any kind of market whiplash. That isn’t happening, and for now the Fed seems more interested in buttressing employment. So far the policies seem to have a bigger impact on asset values than on jobs and wages. Look for the divergence between Main Street and the Dow Jones to continue to widen.