By Michael O’Neill

Authorities have been monitoring what you flush down the toilet since the 1960s.  The practice got really popular during the pandemic as health officials used it to help track the spread of Covid-19 in communities.

Who knew fecal matter analysis would direct billions of health dollar spending? 

Traders, for one.

They are no strangers to fecal matter analysis. It’s what they do every day when they listen to speeches from politicians, central bankers or attempt to interpret economic statistics.  Much of what is said is not far removed from waste water.

The Fed’s inflation debacle comes to mind.

Chair Powell and his colleagues have struggled with inflation for years.  They could not solve why CPI was persistently below the longer-run goal of 2.0% in 2019, which Mr Powell described as “transitory” at the May 1 Fed meeting press conference. 

He was right.  Low inflation proved to be transitory.

When inflation started climbing in 2021 and surpassed the 2.0% target in March 2021, the gains were also described as “transitory.” Hey, why mess with a winning word?

Unfortunately, transitory inflation gains appeared to be growing roots and looked like they may become a permanent part of the financial landscape.

Mr Powell reacted, and the uber-dove embraced the dark side.

Last week Mr Powell warned of “pain involved” in restoring price stability, promising to raise interest rates “until there is clear and convincing evidence” that inflation is falling. 

To be fair, Mr Powell and his colleagues need to rely on a vast array of economic inputs in their decisions, and some of that input may be less than optimal.

Computer science geeks are very familiar with GIGO, garbage in, garbage out.  The concept is simply that the quality of the input determines the quality of the output.

Source: IFXA Ltd

Entire forests have been razed to provide the paper for academic analysis of CPI, including the timing and method of collecting data.  And there is more than one measure of CPI.  The Bureau of Labor Statistics (BLS)also uses a measurement dubbed chained CPI, which attempts to mitigate shortcomings of the headline CPI results.

Employment is another key component in the Fed’s monetary policy deliberations, and that comes with its own headaches.  The monthly nonfarm payrolls (NFP) data is notoriously volatile.  The BLS surveys about 141,000 businesses and government agencies, and billions of dollars change hands with every release.  It doesn’t mean it’s accurate.  NFP rarely agrees with the Automatic Data Processing (ADP) report, a private sector employment report measuring similar criteria.

Price Stability and employment are the reason for the Fed’s existence.  The minutes from the May 4 FOMC meeting underscore the difficulty the Fed has in setting monetary policy.

 Policymakers have to make decisions amidst a challenging global economic outlook.

China’s Covid crackdown exacerbated supply chain disruptions while Russia’s invasion of Ukraine destabilized the European Union economy,  elevating recession risk.  The FOMC minutes noted that the above events were putting upward pressure on US inflation.

The FOMC believes the US economy is robust enough to withstand rising interest rates.  The statement noted, “that 50 basis point increases in the target range would likely be appropriate at the next couple of meetings.”

The Fed is the tail that wags the dog.

The Reserve Bank of New Zealand raised its Overnight Cash Rate (OCR) 0.50% to 2.0%  on May 25.

The Bank of Canada hiked its overnight rate 0.50% to 1.0% on April 13.  The currencies of both countries rallied immediately following the news but reversed the gains within 24 hours.  

However, the major G-10 currency’s relationship with the greenback may be changing.

The US 10-year Treasury yield peaked at 3.20% on May 9 and dropped to 2.75% on May 25.  Fed policymakers believe the neutral rate for Fed funds is around 2.40%.  Analysts are starting to consider that US rates may have peaked for this cycle.

That’s not the case in the other G-10 countries, particularly in the European Union, Great Britain, and Canada.

The European Central Banks is waking up to the reality of soaring inflation in the EU and realizing that the time for monetary stimulus is long past.  ECB President Christine Lagarde said as much on May 23 when she predicted an end to negative rates by September.  Her colleague Francois Villeroy said that July and September rate hikes are likely a done deal.

The US dollar rallied on the speculation, and then reality of, Fed rate increases, and it stands to reason that the greenback will decline as the other central banks normalize monetary policy.

If so, the Canadian dollar will rally, getting added support from oil prices, which are likely to remain elevated due to sanctions on Russia.

Fed officials often say that policy decisions are data-dependent, so next time you flush, flush early and often as your actions play a role in formulating monetary policy.