Bond Market: Revealed An Important Review at is president of Cleveland Federal Reserve.  While her speeches are normally general nature. Her May 14 presentation to has detail. Allowing to understand her hawkish analysis of the U.S. economy Fed policy.

To understand how bond Market function let’s begin with her general opinion about the macroeconomy:

Over next, I expect above-trend output growth, continued strength labor firming inflation. I believe the U.S. economy is slightly most employment, from the standpoint of the cyclical conditions monetary policy , and that inflation will reach our symmetric 2 percent on a over the next one to two . is based on favorable underlying fundamentals, including accommodative monetary and fiscal policies, household balance sheets, rising income, a global economy that is improving overall, and stable inflation expectations.

 “Above-trend growth” describes the relationship between projected GDP growth (which is a combination of population and productivity advances, along with increases investment spending) and real growth.  real growth is faster than projected growth, inflation results.  “Maximum employment’ also has inflationary implications.  The basic theory holds that most employment causes inflation.

Mester also bases her future US Bond Market bullish projections on recent developments.  The Tax Cuts and Jobs Act and increased federal spending will increase domestic demand while the synchronous nature of global growth should increase foreign appetite for U.S. goods (although the dollar’s strength could limit growth). These are all sound prognostications.

Let’s turn to the Mester’s opinion about the .  Mester believes the economy is which is largely supported by the data.  The unemployment is 3.9%.  The moving averages of establishment jobs growth are also very strong:

The monthly jobs data is noisy and to many revisions.  Using various moving averages removes that noise.  The 3, 6, and 12- moving average of jobs gains are clustered around 200,000 – a very strong pace for an economy far into an expansion.  Other jobs market data also supports Mester’s “full-employment” description:

The above chart is from the Atlanta Fed; with the exception of wages, indicators are now above respective highs of the last expansion.

As for prices Mester argues, “I expect to see -to- variation in the numbers around an underlying upward trend in inflation, as inflation moves to our on a over the next or so.”  Here, she runs in the same problem that has had for the last five : prices been reluctant to comply with ’s -constant projection for prices to move above 2%.  A look at the moving averages of PCE price increases shows the problem:

As with the jobs numbers, the moving averages remove the monthly noise from the indicator.  Currently, all the moving averages are below the 2% .  And we’ been in this exact before (where the 3 and 6- averages are rising) almost exactly one ago.  While Mester comments that ’s 2% PCE target is symmetrical (meaning would be concerned if prices spent a prolonged period below or above 2%) she seems ready to pull the trigger on hikes before prices are above the 2% for any length of time.

Mester bolsters her argument by noting that anecdotal evidence from in her district indicates increasing pricing pressure.  This is supported by the latest Beige Book, which observed:

Prices increased across all Districts, generally at a moderate pace. were widespread that steel prices rose, dramatically, to the new tariff. Prices for building materials continued to rise briskly, especially for lumber, drywall, and concrete. Transportation costs also generally rose, with contacts citing fuel prices and shortages of truck drivers as the primary causes. were scattered of passing through price increases to customers in manufacturing, , transportation, and construction. generally expect further price increases in the months ahead, particularly for steel and building materials. 

The latest ISM manufacturing adds further confirmation.  Nevertheless, the latest Fed projections don’t the PCE price index rising to 2% until 2019.  Although Mester’s price arguments are on sounder footing than they would been a year ago, is still enough uncertainty surrounding the PCE index to call for caution projecting sharp price increases.

              Mester is undoubtedly one of the more hawkish of the Fed.  Her analysis of the macroeconomy and are strongly supported by the data.  Her view on prices, , are so.  The PCE index’s move above 2% is recent; and the Fed has projected that prices would move above 2% “in the intermediate term” for several , to prices stay weak.  The Fed should wait for the PCE price index to remain above 2% for more than a month before taking a more hawkish polity stance.

Data source: By HaleStewart from XE Currency