Brynjolfsson Clashes With Former PIMCO Colleague McCulley Over Fed Policy

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Yesterday we explained why PIMCO chief economist Paul McCulley explained why he expects Federal Reserve Chair Janet Yellen to let the economy run with loose monetary policy until wage growth finally picks up, and today former PIMCO managing director and current Armored Wolf CIO John Brynjolfsson argues that she may not have much the luxury in the latest Armored Wolf investor letter, a copy of which was reviewed by ValueWalk.

“When inflation is too low, and unemployment is too high, it’s pretty easy to conclude policy (monetary, fiscal or other policies) should be easy,” writes Brynjolfsson. “Conversely, when inflation is above 2%, and unemployment is below NAIRU, it’s pretty clear monetary policy should be tighter than normal.”

Brynjolsson sees CPI hitting 3.5% in the next year

Brynjolfsson is concerned because headline CPI is at 2.2% year on year, 2.6% annualized for the last six months, and 3.5% over the last three months annualized, implying that inflation is accelerating away from the Fed’s 2% target. The Fed actually prefers to look at personal consumption expenditures, which was down from 1.7% year-on-year in May to 1.6% in June and as Brynjolfsson mentions Yellen called the jump in CPI noise, but he thinks that it’s possible for headline CPI to hit 3.5% or higher within the next year.

Brynjolfsson also doesn’t see why Yellen would continue to allow such loose monetary policy (he estimates that the Fed Fund rates is about 4 pp looser than the Taylor Rule prescribes) when every measure of labor force utilization that she has mentioned in her speeches has dramatically improved and unemployment has been falling steadily for the last three years.

Brynjolfsson arm wolf unemployment rate 0814


Brynjolfsson ignores weak wage growth

The disconnect between Brynjolfsson’s and McCulley’s stance on Fed policy is stark. Brynjolfsson ignores the stagnant wage growth that has a lot of people (including Yellen) worried, and wants to see inflation become the higher priority now that labor force participation is recovering. McCulley sees some value in cyclical inflation passing 2%, and wants labor to get a boost from sustained economic growth.

When it comes to predicting what the Fed is actually going to do, which is probably the most important concern for investors, McCulley is framing the issue in the same way as Yellen, while Brynjolfsson thinks that accelerating inflation will force her to change direction or risk losing credibility regardless of how she views the economy right now.

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