Last month the FOMC explained their decision to stand pat by citing two factors: concerns about global developments and the decline in market-based measure of inflation expectations.
Within a couple of business days of the Fed's decision two economists from the San Francisco Federal Reserve published a short paper viewing different ways to forecast inflation. They concluded that market-based measures were the worst at forecasting future inflation. We discussed the paper here.
Let's turn our attention to global developments. At Yellen's press conference it was clear that the main global developments that were worrisome were China. After all it is the world's second largest economy. Although few place much stock in the official estimate of growth, there was a sense that the economy was even weaker still. The precipitous drop in China's equity market and the mini-devaluation inject greater uncertainty and volatility into the global capital markets. China spurred its own "taper-tantrum" like reaction that poses a further headwind on many emerging market economies.
This Great Graphic by David Rosenberg and posted on Business Insider offers a timely corrective to the creeping myopia. It shows the composition of the world's GDP. The US economy is a little more than a fifth of the world's economy. The US consumer is 15% of the world's economy. It is bigger than China's entire economy. Moreover, with a bit more recovery in US capex and residential investment, and a little more rebalancing of the Chinese economy away from investment, US investment can surpass China's investment.
[Read: China’s New Infrastructure Bank Wins Grudging Assent From the US and Japan]
It is possible that the weakness in the latest US jobs report replaces concern about China in the explanation of the Fed not raising rates later this month. We have argued that there are three different ways to interpret the jobs data. First is that it is a bit of a statistical fluke. Other measures of the labor market do not confirm the weakness. Second is that the US business cycle is maturing, and that near full-employment, net jobs growth will likely slow. We suspect that most Fed officials accept one of both of these scenarios.
The third possibility is the weakness in the labor market presages broader economic weakness. Many estimates for Q3 growth have been cut from 2.0% to closer to 1.5%. Some economists fear something worse, like a new contraction. However, the resilience of the US consumer is important. Auto sales in September were a little more than 18 mln units (annualized pace)—the strongest for around a decade. Recall Q2 GDP was revised higher due to consumption. Assuming the consensus is correction, and retail sales, when it is reported next week, shows a 0.3% increase, excluding autos, gasoline and building materials, then core retails sales was the strongest in Q3 since Q2 14.
The preceding content was was originally posted at MarctoMarket.com
