If you ask Loretta Mester, demand across the US economy isn’t weakening as much as some might’ve thought. Or perhaps “might’ve hoped” is more apt.
“Nothing right now is leading me to think I need to be focused on that question,” Mester said Thursday, when asked about a prospective pause in the Fed’s hiking campaign. “My focus really is on [getting] policy in that sufficiently restrictive stance, so that inflation is moving down sustainably to 2%.”
To reiterate the key point from “Finding The North Star In Oz,” published here last week, it’s entirely possible that the Fed’s assumptions about the natural rate are wrong if we did indeed witness an epochal and enduring macro shift over the past two years. If that’s the case, policy may not be as restrictive as officials are inclined to believe after 450bps of rate hikes in the space of just 11 months. Indeed, it’s possible that policy isn’t restrictive at all, which would go a long way towards explaining why the only sector of the US economy that responded reliably to the Fed’s efforts was housing.
Mester is a hawk, of course, and on Thursday she lived up to her reputation. “I saw a compelling economic case for a 50bps increase,” she said, referencing this month’s policy gathering while delivering a speech to the University of South Florida Sarasota-Manatee College of Business. She also referenced a meeting-by-meeting approach to the Fed’s hike cadence. Although she’s not a voter this year, her voice does matter.
Mester’s remarks prompted traders to fully price the May meeting for 25bps, and the market-implied odds of a half-point increase at next month’s gathering rose. She spoke on a day when data showed producer price growth ran far hotter than expected in January, throwing a bit of cold water on the “pipeline disinflation” narrative. Mester indicated she wasn’t enamored with this week’s CPI report, calling it “a cautionary tale.” Retail sales data released on Wednesday, although not adjusted for prices, plainly indicated Americans aren’t retrenching, and thereby aren’t much help when it comes to taming inflation.
Jobless claims data on Thursday was predictably benign. The 194,000 print was below consensus and again underscored the notion that the US labor market isn’t just “resilient,” it’s bulletproof no matter what tech company is cutting jobs on any given day.
Continuing claims rose, but were in line with consensus. The four-week moving average for initial claims is loitering below 190,000. In short: There’s no evidence to support the idea that the labor market is on the verge of cracking. That doesn’t mean it can’t or won’t. It just means evidence is currently lacking.
Jim Bullard, who likewise doesn’t vote this year, was also on the record Thursday. He too seemed to tilt hawkish, consistent with his demonstrably aggressive lean this cycle. Although Bullard expressed guarded optimism about the disinflationary trend in 2023, he nevertheless warned the window for the Fed won’t stay open forever. Officials risk a repeat of the 1970s if inflation isn’t lowered soon, he said, adding that the benefits of coaxing this particularly boisterous genie back in the lantern posthaste are “vast.” He called for “continued” rate hikes from his colleagues.
In his daily, JonesTrading’s Mike O’Rourke took a look at historical instances when the annualized rate of three-month average core CPI was between 4% and 5%. There were 67 such episodes looking back four decades. The table below from O’Rourke argues against the notion that policy is restrictive.
“Investors need to give strong consideration to the possibility that the FOMC’s rate hikes were not aggressive at all considering the starting point and policy is not meaningfully restrictive enough to push inflation back down to the 2% target,” O’Rourke said.
Although I’d caution that the best time to fade a macro narrative is typically when it starts to get lots of buy-in, the case for “no landing” is now very compelling in the US. This was floated some time ago by, among others, BofA’s Michael Hartnett. Now, “no landing” is finding its way into mainstream media headlines on the usual multi-week lag.
Thursdays can be tediously boring affairs, and notwithstanding a late-session swoon on Wall Street, this week was no exception. The late selloff aside, the session was consistent with an equity market that, for whatever reason, just doesn’t seem to care all that much about how many more times the Fed manages to hike rates.
Ostensibly, there’s a mathematical limit on stocks’ apathy. Rates are a factor in valuing equities after all, and if 6% Fed funds is in play (which it might be), then stocks are almost surely mis-priced. Ultimately, though, it’s conceivable that at least some investors are coming around to the notion that the “no landing” scenario needn’t be a bad outcome. In fact, it could be conceptually similar to “Goldilocks” assuming you accept, as some now do, that 3.5% inflation is just something we’re going to have to live with, even if the Fed doesn’t concede the point for another year or two.
“A prominent feature of our conversations with clients to begin the year has been the idea that inflation is structurally higher than it was before the pandemic,” BMO’s Ben Jeffery and Ian Lyngen wrote Thursday, noting that while the Fed can’t move the goalposts now without undermining their credibility further, “once core-PCE is returned to 2%, a more drawn out academic review of the inflation mandate may begin.”
Given the gravity of that debate, any such review would surely drag on for a year, if not longer. By the time any change was officially announced and enshrined in policy, the public would’ve long since acquiesced to a de facto higher target. Don’t forget: Prices for many of the things people desperately need — like education and health care — have been rising inexorably for decades.
Brainard, the leading Fed dove, is going to the White House. Even if replaced by one of like mind, that new dove won’t have Brainard’s influence on the FOMC for some time, if ever. Thus it seems the Fed may tilt a little more hawkish.
On the mathematical impact of rates on valuation, something to consider is that if the long-run inflation expectation rises to 3% instead of 2%, then investors may be tempted to raise the terminal growth rates in their valuation models, which are built on nominal growth. Bumping terminal growth by +100bp will mechanically but substantially lift valuations.
That said, it looks like the 10 year has a date with >4% and rising 10 year has un-coincidentally coincided with market downdrafts in the past year.
All very sensible sounding.
The lynchpin is a continued shortage of labor. I might say “shortage” because how many of those much-touted job openings are for service jobs no one really wants? Like working at a physical & emotionally draining position at a nursing home for $11 an hour?
A homework assignment for Mester and Bullard: when you are out eating or shopping at a venue with a “We’re Hiring” sign, ask to see the listings, the specifics. Details like are you only offering part-time or split shift positions? How many are 40+ hours per week? It would be a fun detective project for them!
Without a fast relaxation of immigration augmented by the efforts to lower the minimum working age requirements in many red states, will those jobs ever be filled? Maybe there are just too many enterprises still out there that are only financially viable if they can pay $8 an hour to part-timers. Wouldn’t free market adherents agree that those businesses should just shut their doors now?
If that (unprofitable unless $8/hr to PTE) describes a whole industry, then it seems likely that prices will be forced up, maybe through industry consolidation. Unless the US imports cheap foreign labor en masse (unlikely, politically) or technology swoops in quickly (where’s the VC interest in bed-pan changing and toilet-cleaning robots).
If a business cannot pay a living wage, then it should shut it’s doors.
People should not be held, effectively, in a state of indentured servitude.
There are no easy answers, but modern day slavery is no answer at all.
I have tracked the “all-in” costs for undergraduate studies (tuition, room, board, fees, books etc.) to attend 20 US top-tier universities over an 8 year period beginning with the 2014/2015 school year. The average cost for those 20 schools, before scholarships or tuition assistance, was $60,184 for the 2014/2015 school year. For the 2022/2023 school year, the average cost for the same group of 20 schools was $78,607. The rate of increase ramged from 2% to 7% annually over this 8 year period, and, on average, equates to a 3.4% annual increase in costs.
CPI is out of date because the CPI bucket no longer seems to match current spending patterns nor does the CPI bucket adequately take into consideration disinflationary items.
How many people are attending top-tier universities and more importantly, how many are paying the “all-in” sticker price? Some families pay that full amount and others are paying virtually nothing. Most are paying some significant discount to the full price.
Most reading this will not like this solution to inflation, but I will say it anyway:
Reduce the social welfare backstop to a level that encourages people to work, increase immigration to match job openings and significantly increase oil production.
And use anti-trust to break up the gargantuan corporate entities that are draining the lifeblood from American capitalism.
Also, tax the heck out of the rich who suck the blood out of everyone else.
What’s good for the goose is good for the gander.
If people must be “encouraged” to work at meaningless low pay jobs, then the rich can pay their fair share in taxes.
Misery loves company, and no one needs to break their back so that Elon can have a 12th child.
I was in the soft landing crowd but have changed sides to Mester’s team. There is nothing, in my day-to-day reality, to suggest that inflation is cooling. Everything is too damn expensive.
BTW, how do I short BTC-USD?
Anecdote: I decided that with PC prices crashing and DRAM at a buck, it must be a great time to replace my three-year old workstation. I priced out the same brand, equivalent model, similar point in the CPU hierarchy, same graphics cards, etc. The price works out to be +30% more than I paid on Feb 24, 2020. What the . . . conclusion: for this commodity-like good, inflation may be negative MOM and YOY but PC prices haven’t crashed nearly enough.
While housing may be the one easily identifiable (for most people) sector that’s so far “responded reliably” to the Fed’s interest rate increases, I work in the closely related sector of commercial real estate (including rental apartments). I can tell you this sector has been in a state of shock since 3Q22 and values/transactions have been thoroughly beaten down. “Higher for longer” (vs. a nearly 14+ year capital structure built on near zero interest rates) is going to absolutely hammer the commercial real estate sector.
Commercial Real Estate (after 2020’s shock) is going through a permanent structural change – remote working isn’t going back into the toothpaste tube. Many white collar workers just sit in front of a computer all day – and there’s hard data of a year of “stay at home” that it’s still productive enough.
For real efficiency consider all the time lost commuting, fuel burned and vehicle wear, parking lots, dry cleaning, etc.
Like any auction/market, without bidding, the downtown skyscrapers and anywhere else to stuff humans together so they sit in cubicles are overbuilt for demand.
Sadly, I sincerely doubt they can be converted to the much needed housing.
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Thanks for the Jones chart. That was very enlightening. I lived thru the real hawk period with Volcker in charge. Given how tough it was for even those rates to knock down the inflation monster, and given the info in the table, we’ve got a ways to go if we really want to tame prices this time.
I think you are right on! We have a ways to go with interest rates if you look at historical numbers. We have been living in Nirvana for about 15 years and that is just not normal.