Weekly Update 2/3/2023: Fed Raises Benchmark Rate by 0.25%
- CACI accelerates buyback program
- JNJ talc issues continue
- Payrolls and job openings surge
- Stryker zooms higher
- Plenty more SGK Core earnings reports
All about the Fed
As expected, the Federal Open Market Committee met this week and decided to boost its benchmark federal funds rate by 25 basis points (0.25%). According to the statement that accompanied the decision: “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” The market definitely zeroed in on the phrase “ongoing increases” as some hoped that this would the last hike and others anticipated maybe just one more. The statement continued: “In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.”
Definitely a lot to unpack in those sentences. Less than a year ago, the benchmark rate range was 0.00%-0.25%. With this week’s decision, that jumped to 4.50%-4.75% continuing one of the sharpest rate hike programs in Fed history. For the market doves out there, the 25 basis point move was half the 50 basis point hike instituted in December. And that move was less than the four consecutive 75 basis point increases prior to the December bump. While Fed governors will take into account all of the hikes over the past year, they acknowledge that monetary policy works with a lag, and it will take time to determine what will be the ultimate effect on the economy. Meanwhile, the Fed has been reducing its holdings of government securities in a process known as quantitative tightening which does not get the same spotlight as the interest rate hikes but still ultimately removes liquidity from the markets. And, just to make sure the message is heard, the statement includes the term “strongly committed” to describe the Fed’s determination to meet its stable level of prices mandate. The statement also concluded that the rate decision was unanimous. Fed governors give speeches at various times of the year and sometimes their talks contradict each other. Given that the decision this time had no dissents is an important signal that all voting members are on board with the path chosen.
The markets roared higher once it digested this information and heard from Chairman Jerome Powell at the post-meeting press conference. Mr. Powell broke down the inflation situation into three distinct parts. First, goods inflation has already shown signs of becoming nearly deflationary. He said this is what they expected to happen…in 2021. Obviously, it didn’t, as many supply chains stayed knotted throughout most of 2022 making it difficult to match aggregate demand—fueled by pandemic transfers from the government and solid corporate balance sheets—with aggregate supply of constrained goods like semiconductors, lumber and other items. Granted, goods prices can turn around once again and become more expensive especially if China, whose economy has weathered the post-zero Covid transition successfully, starts pushing up the price of commodities. However, the market assumes the goods inflation box has been checked off.
Second, housing has been hurt by the Fed’s hikes and is showing signs of disinflation in the pipeline. Because of the way the government collects and tabulates housing sales and rents—sometimes up to six months after they are in force—Fed officials can see that prices in this sector have been falling and will weaken further. We have reported on this trend recently as evidenced in the weak existing and new home sales data. Landlords, especially those in downtown locations, are still facing higher than pre-pandemic vacancy rates which show little signs of improving now that the work from home trend has taken a firmer hold. Thus, while this box cannot quite be checked off yet, it is close.
The third and most stubborn portion of prices are related to core expenditures for services excluding housing. This so-called “supercore” inflation measure rose about 0.3% in December from November according to the latest personal consumption expenditure (PCE) data released last week. On a three-month annualized basis, that is up 4% which is a decline from October’s recent peak of 5.6% but still too hot compared to the pre-pandemic pace of 2.5%. What comprises this category? A root canal, a car wash or what we do—provide financial advice, all fall in this category and makes up more than half of the PCE core measure. The core is important because it tends to dictate the direction of the overall PCE which is how the Fed meets its 1977 Congress mandate that it “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” This supercore is closely linked to the cost of labor making it stickier than other categories. What the market liked from Powell’s answers was the fact that he and his colleagues believe that they are “close” to seeing this category begin to exhibit the type of disinflationary decline that the other two buckets described above are showing or will soon exhibit.
JOLTS and Payrolls
Which brings the discussion back to the critical item: labor. The Fed cannot control who will apply for a job or who might up and quit for no reason. But they can have an affect on how expensive that labor is through their monetary policy which is why they monitor the data so closely. The Jobs Openings and Labor Turnover Survey (JOLTS) was released before the FOMC meeting came to a conclusion. The number of available positions climbed to a five-month high of just over 11 million in December from 10.4 million a month earlier. The increase was the largest since July 2021 and mostly reflected a jump in vacancies in accommodation and food services. Vacancies declined in the information sector which includes many technology jobs and has been the source of many layoff announcements over the past few months. The JOLTS figure exceeded all economists’ estimates in a Bloomberg survey of economists that had a median projection of 10.3 million. Compared to a 1.2x ratio before the pandemic, the ratio of openings to unemployed people rose to a near record-high 1.9x in December from 1.7x a month earlier. Contradicting the clearly inflationary trend seen in the JOLTS report was another data point. The Labor Department reported on Tuesday that a broad gauge of wages and benefits known as the employment cost index slowed in the final three months of 2022.
For the fourth time in five weeks, initial unemployment claims fell suggesting resilience in the labor market. According to the Labor Department, claims ticked down by 3,000 to 183,000 in the week ended Jan. 28, the lowest since last April. The median forecast in a Bloomberg survey of economists called for 195,000 applications. Continuing claims, which include people who have already received unemployment benefits for a week or more, fell to 1.66 million in the week ended Jan. 21. Economists note that weather during winter months can have an impact on the weekly total. For example, California, which is one of the nation’s largest states by population, has been hit by floods earlier in the year, Texas is struggling with icy conditions and snowfall blanketed parts of Nevada including Las Vegas this week.
Most of this week’s attention outside the Fed meeting was centered on the monthly payroll report from the Labor Department. For January, the number of non-farm payrolls rose 517,000 after an upwardly revised 260,000 gain in December. A yearly update to the establishment survey revised job growth higher for the final six months of 2022. The unemployment rate last month dropped to 3.4%, the lowest since May 1969. Government hiring increased by the most since July (thanks in part to the return of University of California workers from a strike) while leisure and hospitality, health care and professional and business services were also strong. Average hourly earnings rose 0.3% from December placing them up 4.4% from a year earlier. That statistic may be more important than the number of jobs because the Fed is more concerned about how wages will be spent fueling inflation not necessarily how many people per se are punching the clock each month. Average workweek rose to 34.7 hours, the highest since March, suggesting that the current pool of workers is being stretched to produce output. The solution to ease this problem is to make the workers more productive (which takes time), lower output (which sacrifices profits) or hire more workers (which is what we are seeing). An index that combines payrolls, hours worked and wages rose 1.5% in January, matching the largest monthly advance since August 2020 when the nation was beginning to crawl out of the depths of the Covid-19 pandemic. Some economists have pointed to seasonal factors as distorting the report similar to the initial claims information. Others, however, believe the data is doing what it was intended to do—emphasize the trends in hiring even if month-to-month figures may not be absolutely perfect.
The European Central Bank (ECB) also had a meeting this week to set monetary policy going forward for the EU. As expected, the ECB lifted its target by 50 basis points, with President Christine Lagarde saying another such move is almost certain next month, despite conceding, similar to the U.S. Fed, that the inflation outlook is improving. Ms. Lagarde and the Governing Council said it “intends” to raise rates by another 50 basis points at its March meeting, then “evaluate the subsequent path of its monetary policy.” Policymakers said risks to the growth and inflation outlook have become more balanced, calling the economy more resilient than expected. Ms. Lagarde told reporters in Frankfurt, “Our determination to reach 2% medium-term inflation should not be doubted. Nor should be doubted the fact that once we are in restrictive territory we will want to stay there sufficiently. We know that we have ground to cover. We know that we are not done.” The tone and comments were remarkably similar to Mr. Powell as both institutions try to combat inflation without coming across as too hawkish. The ECB also gave more details on how it intends to shrink its €5 trillion ($5.4 trillion) bond portfolio, reaffirming a monthly cap of €15 billion between March and June on maturing debt that’s allowed to expire. On Wednesday, the Bank of England also voted for another half-point hike. The U.K. pound trades independently from the euro as the country never relinquished its currency at the start of the century unlike many large European countries like Germany and France.
The Fed is in a tricky situation, but one it has been balancing for nearly a year. Tightening rates too much could cripple growth and tip the economy into a recession. Not being hawkish enough may let inflationary forces bubble under the surface only to reemerge stronger and more assiduous down the road. Current Fed governors are haunted by mistakes of the 1970’s where stop-and-start tightening and loosening of policy handicapped growth for years. That ultimately led to then Chairman Paul Volcker shepherding an unprecedented rate hike march which itself led to a “double dip” recession in the early 1980s. Nobody wants a repeat of that episode. The bottom line is the wage-price spiral which defined the ‘70s is not at work—yet. Inflationary expectations for the next year are 3.9% versus 2.9% for the 5-10 year period according to the latest University of Michigan sentiment report. But opinions can change. Walmart, the largest private employer in the country, just raised its minimum wage. Twenty three states and Washington, D.C. raised their minimum wage on January 1 affecting about 8 million workers. How much longer before workers will not have to ask for raises but merely expect them to happen? When that occurs, the Fed’s job will become much harder which is why they are so determined to stop the spiral before it takes off. Stay tuned.
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