The Fed is focusing on 'flawed' data and keeping rates high will result in a big policy mistake, economist says

Various indicators show the Fed may be looking at the wrong data points to inform its higher-for-longer interest rate path, David Rosenberg says.

• The Fed's reliance on "flawed" inflation data to keep interest rates high will spur a policy mistake, David Rosenberg says.
• The latest PCE and GDP data may be misrepresenting the actual state of the economy.
• The Fed has been too optimistic about jobs data that's based on nonfarm payrolls, Rosenberg said. 

The Federal Reserve's fixation on a streak of "flawed" data to justify keeping interest rates higher for longer is bound to spark a policy mistake, according to top economist David Rosenberg. 

"The Fed seems to be focusing not just on flawed data, but on headlines only. I don't sense any analysis of the data by the various FOMC officials as much as reporting of the data," Rosenberg said in a note on Monday. 

He said the reverberations of such a misstep wouldn't hit until six months later, but when they do, the Fed and the markets are in for a shock.

"The Fed now intends to stay on the sidelines as it closely watches lagging and contemporaneous indicators that are littered with high error terms, and the longer it waits, the more it is going to have to do on the rates front. Shades of 1991, 2001 and 2008," he wrote.  

Rosenberg criticized the Fed's focus on its favored PCE inflation data, which spiked higher than estimated at a 3.7% annual rate in March, making the central bank believe it's still too early to loosen the monetary policy. 

The economist pointed out that first-quarter data paints a narrow inflation picture, mainly driven by three idiosyncratic items: financial services and insurance, healthcare services, and housing and utilities.

"I don't see how the Fed can influence these inherently non-cyclical areas. And it is unclear how long-lasting these influences will be," he said, adding that excluding the three items above, core PCE inflation edged up by only 1.5% annually in Q1. 

Rosenberg noted that even the tepid 1.6% annualized real GDP growth in the first quarter was mainly driven by government, healthcare, and financial services. Beyond these sectors, real consumer spending only saw a modest uptick of less than 2% annually, far from a "hot economy" narrative. 

"Meanwhile, household expenditure on both durable and nondurable goods contracted at a -0.4% annual rate, and these are far more exposed to the shifts in the economic cycle," the note said. 

Finally, he noted that the Fed's long-term view of the economy as still hot based on non-farm payroll data was dashed by the Quarterly Census of Employment and Wages and Business Employment Dynamics.

Rosenberg pointed out that the payroll report may be exaggerating actual employment by 70,000 per month. This is because the lagging, more comprehensive QCEW data only showed a 1.5% rise as of September 2023, while the widely used nonfarm payroll report indicates a 2% growth every month.

Meanwhile, BED data indicated a 192,000 drop in private employment in Q3 of last year, whereas private job payroll data reported a significant 521,000 increase in that time. 

"We have not seen a decline like this since the first and second quarters of 2020, but we also had this sort of drop in the third quarter of 2007 and the first quarter of 2001."