A version of this post was originally published on TKer.co
Stocks rallied last week, with the S&P 500 up 3.5%. The index is up 7% year-to-date, 14.9% higher than its Oct. 12 closing low of 3,577.03 and 14.3% lower than its Jan. 3, 2022 closing high of 4,796.56.
Much of the market volatility over the past year can be explained by the Federal Reserve’s ongoing struggle to bring down inflation with increasingly tight monetary policy.
I’m not one to delve into the past, but it’s become fairly commonplace for people to bash the Fed for getting monetary policy wrong from an inflationary perspective. In particular, many point out that inflation has been stubbornly high because the central bank made a “mistake” by being too slow to end stimulative monetary policy.
These critics are not necessarily wrong. But assuming the Fed had slowed the economy as inflation started to rise in 2021, where would we be today?
Federal Reserve Board Chairman Jerome Powell holds a news conference after the Fed hiked interest rates by a quarter of a percentage point after a two-day Federal Open Market Committee (FOMC) meeting on interest rate policy in Washington, United States, March 22. 2023. Portal/Leah Millis
If such a move works and inflation eases quickly, then the economy is also unlikely to be as strong as it is today. After all, monetary tightening is about cooling demand – and that means the job market probably wouldn’t be as resilient as it is today.
Would everyone agree?
Keep in mind that the number of people who found jobs during this period of high inflation is huge. And the money these newly hired people make helps keep inflation high as they bring more demand into the economy.
In February this year, total employment on the payroll was a record 155 million. That metric only returned to its pre-pandemic level of 152 billion in June 2022.
Meanwhile, inflation became particularly alarming in June 2021, when the CPI rose above 5% for the first time since 2008. At that point, the total number of employees was much lower at 147 million.
(Source: BLS via TKer via Fred)
Likewise, the unemployment rate in February was a very low 3.6%. It only fell back to the pre-pandemic level of 3.5% in July 2022. In June 2021, when inflation sounded the alarm, it rose to 5.9%.
The story goes on
(Source: BLS via FRED)
To be clear, this is a discussion of counterfactuals, meaning there is no way of knowing exactly how things would have played out under alternative scenarios.
But it’s not unreasonable to imagine a world where inflation today was closer to the Fed’s target rate of 2% because the central bank acted quickly to rein in demand. The Fed’s critics would argue that this could have happened.
Without less employment, however, this is hardly imaginable. Perhaps the workforce would be over 147 million and the unemployment rate below 5.9%. But it’s hard to imagine the numbers coming very close to the 155 million and 3.6% we’re enjoying today.
So which is worse: high inflation or high unemployment? 🤔
This is the kind of compromise worth philosophical examination: is it better to have moderate inflation with 147 million employed while 8 million struggle with unemployment? Or is it better to let 155 million workers participate in the fight against high inflation?
I don’t know how to answer these questions. (Though I’m eager to read your thoughts in the comments!)
One of the reasons I’m asking these questions now is that I was struck by Senator Elizabeth Warren’s remarks to Fed Chair Jerome Powell on March 7 during his appearance before the Senate Banking Committee.
Warren pointed out that the Fed’s own forecasts at the time assumed the unemployment rate would rise to 4.6% by the end of the year, which she said could mean two million people would lose their jobs. It was a harrowing but fair observation.
But again, I can’t help but think about how this scenario would compare to alternative scenarios. Would it have been better if employment levels had never become as strong as they are today? In the past six months alone, two million jobs have been created. Is it better never to have hired those two million people? Or is it better to hire two million people and then lay off two million in a matter of months?
To be clear, the economy is not so simple that we should only look at the binary results offered above.
All I’m suggesting is, if you’re going to argue that the Fed was wrong in implementing monetary policy, then also imply that it was a mistake in fostering an environment that has historically helped create millions of jobs has led 2 years.
All in all, all eyes are back on the monthly jobs report, which will be released Friday at 8:30am ET.
Relatives of TKer:
Review of macro cross currents 🔀
There were a few notable data points from the past week to consider:
🎈 inflation cools
The personal consumption expenditure (PCE) price index rose 5.0% yoy in February, up from January’s 5.3% increase. The core PCE price index — the US Federal Reserve’s preferred measure of inflation — rose 4.6% for the month after rising 4.7% the previous month.
Month-on-month, core PCE rose 0.3% in February. This was down from January’s 0.5% rate. If you annualize the three-month trend in monthly numbers, core PCE is increasing at a rate of 4.9%.
(Source: @NickTimiraos)
The bottom line is that while inflation rates have been tends to be lower, they remain above the US Federal Reserve’s target rate of 2%. For more on the implications of cooling inflation, see: The bullish “Goldilocks” soft-landing scenario everyone wants 😀.
🛍️ Consumer spending increases
Private consumer spending increased by 0.2% in February.
(Source: BEA via FRED)
Adjusted for inflation, real spending fell by 0.1% over the period.
(Source: BEA via FRED)
Conclusion: Consumers continue to spend at record levels. For more information on consumer strength, see: 9 reasons to be bullish about the economy and markets 💪.
🏠 House prices cool
According to the S&P CoreLogic Case-Shiller Index, home prices fell 0.5% mom in January, the seventh consecutive month of declines. SPDJI’s Craig Lazzara: “This month’s financial news has been dominated by turmoil in the commercial banking industry as some institutions’ risk management functions proved unable to cope with rising interest rates. Despite this, the Federal Reserve remains focused on its inflation reduction goals, suggesting that interest rates could remain elevated in the near term. Mortgage financing and the prospect of economic weakness are therefore likely to remain headwinds for house prices for at least the next few months.”
(Source: SPDJI via FRED)
For more information on the refrigerated housing market, see: The US housing market has gone cold 🥶
🏢 The offices are half empty
From Kastle Systems: “Office occupancy rose more than a point to 48.4% last week, according to the 10-City Back-to-Work Barometer.”
(Source: Kastle Systems)
Fridays are the emptiest: “The daily high was Tuesday at 57.9% and the low was Friday at 31.3% occupancy.”
(Source: Kastle Systems)
For more information on empty offices, see: This office statistic reminds us that things are anything but normal 🏢
💼 Unemployment claims remain low
Initial jobless claims — the most recent of the major jobs statistics — rose to 198,000 in the week ended March 25, up from 191,000 the week before. While the number has risen from its six-decade low of 166,000 in March 2022, it remains close to levels seen during periods of economic recovery.
(Source: DoL via FRED)
You can find more about low unemployment at: The job market is hot 🔥, cooling 🧊 and somehow problematic 😵💫 at the same time.
👍 Consumer confidence is improving
From The Conference Board: “Driven by an increase in expectations, consumer confidence improved somewhat in March but remains below the average level of 2022 (104.5). The gain reflects the improved outlook for consumers under the age of 55 and households with incomes of $50,000 and above… While consumers are slightly more confident about the future, they are slightly less optimistic about the current landscape. The proportion of consumers who say there are “many” jobs has gone down, while the proportion who say there are “not that many” jobs has gone up. The latest results also show that their inflation expectations for the next 12 months remain high – at 6.3%…”
(Source: The Conference Board)
💸 Consumers plan to buy less of things they don’t need
From The Conference Board: “…consumers plan to spend less on highly discretionary categories, such as B. playing the lottery, visiting amusement parks, going to the cinema, personal accommodation and restaurants. However, they say they will spend more on less discretionary categories like health care, home or auto maintenance and repair, and economical entertainment options like streaming. Spending on personal care, pet care, and financial services like tax prep is also likely to remain.”
(Source: The Conference Board)
💸 Outflows of small bank deposits are stabilizing
Here’s JPMorgan on the Fed’s latest H.8 report: “Deposits at small banks (all but the 25 largest) rose $6 billion in the week ended March 22nd. Large banks (which include one bank backed by an industry consortium) saw deposits fall by $90 billion last week, more than reversing deposit inflows of $67 billion the previous week.”
(Source: JPMorgan)
You can read more about banks here: As if the economic prospects weren’t already difficult to predict… 🤦🏻♂️; Same goal but now a more treacherous path 🚧; and A few thoughts on the failure of Silicon Valley Bank… 🏦
📈 Near-term GDP growth estimates remain rosy
The Atlanta Fed’s GDPNow model projects real GDP growth to increase by 2.5% in the first quarter. While the model’s estimate differs from its peak, it is still well above its original estimate of 0.7% growth as of Jan. 27.
(Source: Atlanta Fed)
All together 🤔
Despite the recent banking turmoil, we continue to receive evidence that we could see a bullish “Goldilocks” soft landing scenario, in which inflation cools to manageable levels without the economy needing to slide into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time the disinflationary process has begun”. And on March 22, the Fed signaled that the end of rate hikes was near.
In any case, inflation has to fall further before the Fed can get comfortable with the price level. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards and lower stock valuations).
All of this means that market thrashing could continue for the time being and the risk of the economy sliding into recession will be relatively high.
However, it is important to remember that while recession risks are heightened, consumers are coming from a very strong financial position. Unemployed people get jobs. If you have a job, you get a raise. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. From a consumer point of view, it is still too early to sound the alarm.
At this point, a downturn is unlikely to turn into an economic disaster as the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that when you enter the stock market for long-term returns, recessions and bear markets are only part of the story. While the markets have had a pretty rough couple of years, the long-term outlook for equities remains positive.
A version of this post was originally published on TKer.co
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