On August 26th Fed Chair Jerome Powell addressed economists and decision-makers at the Fed’s annual Jackson Hole conference. His remarks had been anticipated for months. The inflation raging through the economy and repeated Fed rate hikes have deflated some of the bubbles we saw at the start of 2022.
The question is, will the Fed slow its rate hikes and allow the economy to have a “soft landing” or will the Fed keep raising rates potentially crashing the economy…
Powell left no doubt about the path forward.
Powell said, “Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” (1)
Powell continued, invoking the Fed’s experience during the 1970s
“Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”
In the 1970s the Federal Reserve, Led by Chair Arthur Burns, raised rates to drive down inflation. Rates were raised to a point higher than inflation, inflation slowly eased. However, because of Fed tightening and high inflation the economy rolled over into recession. To help the economy, the Fed started cutting rates. As the Fed lowered rates, inflation went back up to new higher levels. This happened several times during the 1970s leading to multiple recessions, until Voelker raised rates in 1980.
“There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.”
Powell invokes the legacy of Volcker during his speech,
“During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision-making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, “Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.””
The reality is we are in year 1 of this new inflationary era. Volcker came in after the nation had battled inflation over 10 long years.
In a speech Burns gave in 1974 describing the battle with inflation you could sense the exhaustion and frustration in his voice. (2) He had been fighting inflation for 4 years. The country had another 6 years of exhausting inflation before Volcker became Fed Chair. We have a long way to go…
Powell finished his speech by addressing the issue of labor,
“…we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase if we delay, as high inflation becomes more entrenched in wage and price setting.”
Unemployment will have to go up “causing households a great deal of pain”. If inflation persists, higher levels of unemployment will be caused in the future.
Powell reveals his sternness and commitment,
“A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year.”
“We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done.”
In reaction to Powell’s speech markets sold off and continued to decline for several days.
A week later, the jobs report for September was anticipated to give guidance to the Fed. The jobs report estimate was for 298k; previous report showed growth in jobs of 528K. This was a huge number and shows the economy is not yet decelerating enough to lower employment market pressures. (3)
Jon Ferro sets the stage for what Jobs Day… “The Fed is trying to get unemployment higher, materially higher, something closer to 4% by year end…”
Priya Misra, TD Securities
“The market is largely priced for a 75bp hike in September. We are expecting a large jobs number today and strong wage growth.”
Jon Ferro, Bloomberg host asks Misra about the economic impact of higher rates.
“I’m worried about a Nonlinear market response when the recession begins. When unemployment goes up and if the fed keeps hiking instead of pausing, financial conditions will tighten dramatically.”
“If there is a Recession, I think default risk in corporate bonds is underpriced. You have to determine what companies have cash, have strong balance sheets. Weak companies are vulnerable as rates rise and conditions tighten.”
“Since Powell’s speech at Jackson Hole, the 2 year yield has been higher every day, today breaking through 3.5%” said Ferro.
Carl Riccadonna, chief economist BNP Paribas
“We are in the endgame for the Fed I think. The fed is trying to downshift. But as Powell pointed out at Jackson Hole, the labor market is not helping with that downshift. I think we will see that continue today.”
“The Fed is trying to push us into a long-term period of low economic growth. It may mean a recession, but not necessarily. Last year we saw a 12% real GDP print and we have seen a huge deceleration.”
“There is a lot of tightening in train. The Fed does not want to be guilty of murdering the economy.”
Randy Krozner, Univ. of Chicago Booth School and former Fed Gov
“Labor market is very tight, lots of wage pressure just as John Taylor was talking about. A lot of excess job openings by companies. We need to remember, ‘Fed policy acts with a Long and variable lag,’ as Milton Friedman famously said.”
Job estimates for the report range from 75,000 jobs created to 452,000… it will give a view into the health of the economy and jobs market, and ultimately inflation.
“Bond market is speaking here…” injected Tom Keene. The 2 year US treasury bond yields have moved up over 3% since the beginning of the year.
At 830am the jobs data was announced…
315k jobs created in August, this was more or less in line with estimates.
Average earnings were weaker than expected up .3%, compared to an estimate of .4%.
Labor Force Participation rate rose to 64.4 from 64.1 the month before, showing more people coming into the labor force.
The unemployment rate rises to 3.7%
August average Work week declined to 34.5, vs an estimate of 34.6
“This is a report the fed would have designed for itself.” says Jon Ferro.
“Revision to employment numbers down over last three months, this is very Fed friendly.” adds Michael Mckee.
Randy Krozner adds, “Labor Force Participation going up can relieve some of the pressure on the labor market. It is consistent with where the fed wants to go.” Rising and higher inflation is pushing people into the labor force…
Tom Keene chimes in, “This report pushes away a lot of the arch-gloom that was out there.”
Michael Mckee says, “There are no standout categories of hiring or layoffs, there is good breadth on the report. The exception is the mortgage industry, but that’s to be expected given what’s going on in housing.” The rapid rise in rates has caused a slowdown in mortgage lending and housing sales.
After taking in the data, Tom Keene adds, “This is one data point. We need a whole string of data points through the next 6 months to get a solid picture.” The Fed has repeatedly stated that policy will only ease after many months of data that proves that inflation, especially wage inflation, is declining rapidly and permanently.
Rick Rieder, Blackrock
Reider says, “The report gives the market and Fed a chance to take a sigh of relief. The labor market is in solid shape. The economy is in solid shape, especially the service sector.”
When asked about what this means for people how are investing in the markets, Reider said, “We are carrying a lot of cash. The Fed is tightening financial conditions, draining liquidity, and we still see risk of lower markets.”
Jim Bianco, Bianco Research
Jon Ferro asked Bianco, “How difficult is it to reconcile the economy and the market?”
Bianco responds saying, “We can look at the economy, but the fed is focused on inflation.”
“Something for everyone today. Fed will welcome muted wage growth and higher unemployment rate.” Says Ferro.
Mckee contributes, “This Keeps the soft-landing narrative alive… the unemployment rate rising to 3.7 from 3.5 because we saw a lot of people come in to the labor force; 786k looking for jobs and that is flattening out the wage pressure. This is what the Fed wants to see.”
In response, markets rose.
The following week, the CPI report was released on Tuesday, September 13th. The data was highly anticipated.
Will inflation ease? Will it worsen? Are the Fed’s rate hikes being effective or will the Fed have to raise rates a great deal more?
Ferro set the stage for Tuesday’s report, “It is the last big data point before the Fed decision for September. Most people are looking for a softer print.” (4)
Kit Juckes of SocGen described the inflation, “Too much money chasing too few goods, too few people doing too many services…”
Andrew Hollenhorst, Citi Chief Economist
Ferro asks Hollenhorst, “Do you think we are underestimating the persistence of this inflation and the resolve of this Fed?”
He answers, “I think that’s always a danger… underestimating. We need to be really careful to not let hope triumph over the reality of the situation. Want to see services slowing down, want to see rents declining… falling used car prices alone is not going to be enough. There are some acute upside risks to inflation.”
Hollenhorst continues, “We need to see a somewhat significant rise to unemployment in order to ease wage pressure in labor markets.”
Ferro rhetorically asks, “Are we going to see a Fed pivot in September to easier conditions?”
Mark Cabana, BofA US Rates Strategy
“I think this inflation report will be the start of a trend with inflation moving lower. If there is one indicator that is driving the Fed, it is the labor market. It really seems like the Fed wants to see a material softening in the labor market. That drives the risk of a recession in the future and has driven the Fed to sound more hawkish.”
At 830am the CPI report came out
Michael Mckee pronounces, “It is a little bit higher, more than the flat reading we had last month… this pushes the inflation rate to 8.3%, the forecast had been for 8.1%. The core which matters more rises double what it increased last month. This pushes core inflation up to 6.3%, from 5.9%. So, some bad news on inflation here…”
Food was up .8%, gasoline was down 10.6%, shelter (rent) rose faster at .7%… (5) Food and shelter are said to be ‘stickier’ forms of inflation and not as volatile.
Mckee finishes saying, “We are a long way from saying inflation is conquered and has peaked. The Fed has still more work to do.”
Tom Keene chimes in, “This is a huge disappointment.”
Equity markets moved lower dramatically. By end of day the NASDAQ was down 5%.
When asked about the impact of the report on Fed policy, Mckee answered, “This guarantees a 75bp hike in September. In the past the Fed has had to raise rates above the level of CPI in order to pull down the rate of inflation. With interest rates currently in the 3’s and core inflation over 6, we either need inflation to come down or the Fed to raise rates a lot more.”
Victoria Greene summed up the September data points… “clearly there is not going to be a Fed pause anytime soon.” (6)
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