inflation, interest rates, risk management

Inflation and Jobs, May 2023

On Weds. May 10th Core inflation held steady at 5.5% y/y. (2) Core inflation excludes the volatile food and energy components.

“It’s a head fake,” said Vincent Reinhart at Dreyfus & Mellon. (1)

From the Fed’s vantage point, “You better be sure when you stop, you’re not going to look back and regret it just a couple months later,” Reinhart said. The Fed really needs to be confident that inflation “is headed back to 2%. This is just another drop in the ocean.”

“Inflation is moderating, but one reason that Fed officials have remained worried about it is that it has been increasingly driven by services costs. Those can be really stubborn and hard to stamp out.” (3) Rising wages are an important contributing factor to services inflation; on Friday May 5th the monthly jobs report wage pressures increased slightly.

On Wed May 3rd the Federal Reserve continued to raise rates by 25 bps in an effort to reduce inflation in the economy. During the meeting Powell declared that the banking system was stable and secure. After trading closed Wed many smaller regional banks declined substantially. PacWest Bank declined 60%, Western Alliance Bank declined 30%. Many others declined as well. (4)

Much of the conversation Thursday May 4th had to do with the weakness in the economy that would be driven by the caution and failure of several regional banks. One concern is that weakness among bank will slow credit creation to such an extent that it pushes the economy into a deep recession.

Priya Misra, TD

“We are all watching banks, I don’t think these numbers matter a lot. But a hotter number above 185 will guarantee there will be no rate cuts any time soon.” Says Misra.

Lisa Abramowicz asked, “What data are you looking at?”

Misra responds, “The Details of Senior Loan Officer Survey and what is the end game for the banks? How much worse is this going to get? Bank failures will slow lending and be restrictive.”

Misra sees the economy slowing considerably… “Next year fed is going to have to cut rates a lot as long and variable lags kick in.” To help the smaller banks, “We need a TARP like system from congress I think.” (TARP was the Troubled Asset Recovery Program, established during the GFC)

Misra continues, “The Fed says they can separate monetary policy from financial stability, I highly disagree with that view.”

Ray Ferris, Credit Suisse chief economist

“This is the Godot recession… we are still waiting for it. We continue to see growth, but it is slowing. We are still printing jobs, but some sectors are seeing job cuts. The fact is as we print jobs people spend more money and the economy chugs along.” Says Ferris.

The ADP number earlier this week showed 296k jobs created putting more pressure on the Fed’s push to lower inflation. Powell has said repeatedly that the Fed needs to see the unemployment rate move higher in order to bring down inflation.

When the May Jobs data dropped the data exceeded expectations…

253k jobs vs 185k est

Average Hourly Earnings up .5% instead of an expected .3% increase

Unemployment rate drops to 3.4%

 “This is miles from where Chair Powell wants things to be…” says Tom Keene.

“Wages are hot… this is not what Powell expected to see a year ago…” injects Jon Ferro. “Bond rates have gone from 0% to 5% in a year and unemployment is still at 3.4%. Unbelievable.”

At the beginning of the year markets excitedly planned for the Fed to cut rates aggressively and they have continued to raise rates. As of May 10, many on Wall Street expect the Fed to raise rates again in June. It is important to remember that Powell is haunted by the ghost of Arthur Burns who was Fed Chair in the 70s and cut rates before inflation was fully under control. When Burns cut rates because of a recession, a few months later inflation took off to higher levels damaging the economy even more.

To discuss this and other issues about the economy and how to manage risk in your portfolio, feel free to reach out to me at james.cox@glic.com

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