The housing sector and inflation
Dr. William Dudley said in his recent speech that the housing sector has been weaker than anticipated due to four factors.
Dudley expects the housing recovery to resume, though at a slower pace.
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With one-off factors like the cut in Medicare reimbursements last April out of picture, Dudley believes inflation will drift upwards over the next year, closer to the Fed’s 2% target. However, he sees little chance of inflation climbing up sharply in the next one or two years, as there’s still some excess capacity available (especially in the labor market) in the country. The wage hike has also been subdued at about 2% in recent times, much lower than the historical average of 3.5% for productivity growth of 1% to 1.5% (the current scenario) and 2% inflation target.
The lower-than-targeted inflation has prompted the Fed to take a dovish stance on monetary policy. Fed officials have reiterated that the Fed funds rate will remain near zero for “a considerable time” after the end of bond buying program and the Fed will take into account a host of factors while increasing it.
Dudley stated that the 2% inflation target isn’t a ceiling and the economy will see inflation around 2%. The Fed would intervene if inflation drifted above 2%. However, if inflation is just above 2% and labor market conditions remain weak, labor market conditions will dominate monetary policy considerations.
Low interest rates in an improving economy have helped investment-grade (LQD) and high yield (HYG) bonds. Treasuries (TLT) have averted much of their expected fall in prices after the taper came into effect in January because of the dovish monetary policy the Fed adopted. The broad-based S&P 500 (VOO) index has gained so far in 2014 due to improving corporate performance. On the other hand, the industrial-heavy Dow Jones Industrial Average (DJI) has remained stagnant due to subdued industrial activity, primarily during the first quarter.
To find out what Dudley said about labor market conditions, read on to the next part of this series.