Happy Fed Day! Today seems to be the most important day of the year… until the next Fed meeting, of course. I started my morning with this tweet and with the level of chatter out there surrounding the Fed meeting, I thought I should pipe in.
There’s no sense in predicting what might happen. The consensus is for 25bps hike but, we never know until the announcement comes. That’s why there’s a lot of volatility around this day. There could always be an element of surprise. But, what could be helpful is recapping what the Fed said and what the macro picture looks like.
To recap, this is what they discussed last time:
If you remember, the last meeting came with the summary of economic projections and the Fed wasn’t taking things too lightly. In fact, to me, it felt like Fed Chair Powell was a little worried, perhaps nervous about the overall situation in the wage rates.
The Fed has feared two things:
Inflation expectations becoming entrenched - This is when people’s expectation of future inflation soars. Volcker had discussed this, as well. It’s very hard to control this issue and when it does happen, people make advanced purchases in anticipation of future price increases and this fuels further inflation.
A wage spiral - This is when people demand higher wages to cope with inflation and that in turn, leads to higher costs for companies. Companies then need to raise prices to cover their costs and that leads to further inflation.
To put it a different way, the Fed never wants to get stuck in an inflation doom loop.
There are a few issues we will be looking for and they surround the same basic issues - job market, inflation, GDP growth and financial conditions. Here's the latest picture:
From the comments in his last press conference, it seemed more like the Fed Chair was getting increasingly worried about a wage spiral. We heard him quote the Employment Cost Index several times and that’s why we highlighted this number during this week’s “Navigating the Markets”.
The Employment Cost Index
The Employment Cost Index number was released yesterday and it showed a quarterly increase of 1% but came in better than expected and lower than the previous quarter’s increase of 1.2%. The YoY increase still remains at 5.1%. So, there some sign of a relief here but, no much. On the plus side, at least it hasn’t accelerated.
What we will look for: An analysis of this quarter’s ECI number and whether they are relieved with it.
The Labor Market
Following on from wages is the state of the labor market. I’m sure you all listened to Mayhem’s timely release yesterday. The Fed made it quite clear that without an increase in unemployment, wage hikes will likely continue to drive inflation.
According to the Fed Chair, with the supply and demand imbalance in the labor market, workers remain unavailable. So, companies are already running on fewer workers than required and don’t want to layoff anymore. We have however, seen some layoffs but whether that’s enough to move the needle, remains to be seen.
What we will look for: A discussion on the supply and demand imbalance in the labor market and whether they're taking note of the layoffs.
Inflation
55% of the PCE is non-core services and this is where they are afraid that inflation will either continue to increase or not reduce enough. This was a relatively new point of emphasis they made and ties in with the ECI and tightness of the labor market. Unfortunately, we saw the Services PCE number increase:
Part of the discussion is also shelter inflation, which is +30% of the CPI and is usually a sticky component. Now, I did some math on the Shelter Inflation and my numbers show this declining in May. If you look at the Chart below and the calculations I've written out, the Shelter CPI follows the Case-Shiller Home Price index quite well with an average lag of 15.8 months. This puts the Shelter CPI peaking in August 2023 but given the aggressive stance of the Feb, I estimate this to be around May 2023. The Fed says mid-2023, which is close enough.
What we will look for: Discussion around whether the Fed still sees the inflation number as sticky and whether they see China as a threat to rising inflation.
Financial Conditions
Financial conditions have started to ease, and this is not helping the Fed’s case of fighting inflation. We’ve seen a number of banks come out with warnings that this rally we’ve had in January is definitely not what the Fed wants to see.
The Fed will no doubt comment on the strong GDP numbers (not being negative is strong enough!). But, I doubt that they will be happy with how much financial conditions still remain loose. It gives them a reason to think that inflation may come back.
Paraphrasing Chair Powell from the December meeting:
Financial conditions fluctuate… but they should reflect monetary restraint.
What we will look for: How hawkish he gets when he discusses this issue!
No one seems to pricing in a surprise for today's Fed rate hike but they do seem to think that Chair Powell will be hawkish. I don't know which way things go... all I can say is good luck out there and be safe. I hope I've given you some clues as to what to look for.
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