This March marks the first anniversary since the Federal Reserve (Fed) began the current cycle of interest rate hikes in the United States. A monetary tightening that, partly because it started too late, has been quite abrupt. In this context, it is worth asking about the next steps of the Fed and about the effect that its actions and speech are having on the economy and the markets.
In the last meeting, which took place from January 31 to February 1, the Fed began to step on the brakes, going from hikes of 50 basis points to hikes of “only” 25 basis points, placing the official interest rate at the range 4.5%-4.75%. And although in the subsequent press conference its president, Jay Powell, made an effort to signal a still aggressive tone, this was tempered by the allusion to the apparent advance of “disinflation” in parts of the economy and the market’s fears of a forthcoming economic recession in the country. The result was that the market did not buy the Fed’s hawkish message, now pricing in not only a lower benchmark rate cap for this cycle, but also rate cuts later this year.
However, market and analyst expectations have turned almost 180 degrees in the last four weeks. For the next Fed meeting, from March 21 to 22, there are more and more voices warning of the possibility of a 50 basis point increase. And furthermore, expectations of a rate cut later in the year have all but vanished. What’s more, some analysts from large American banks go further and suggest that the reference rate will continue to rise to 6%, 125 basis points above the current level.
This is the response to a vision that I do not share, since everything responds to the fact that the latest data imply upward surprises, not only for the data for inflation, but also for employment and activity in the country, which also seem to leave behind the ghosts of recession.
I do not share this vision because the leading indicators or ‘soft data’ do not indicate this, but rather the opposite. These indicators can be discussed, but the fact is that the response rate and participation of citizens and companies is very high, which should translate into a good reading of the economic situation.
The real situation is what is seen looking forward and not in the rear-view mirror of the actual published data. For this reason, as an analyst, I let myself be carried away more by the weakness of the traditional leading indicators, such as the new orders of the PMI, the price indicator in the ISM services sector -clearly downwards-, the yield curve or the LEI of the Conference Board… And the strength of the ‘hard data’ or simply data (payroll, retail sales) does not give me confidence. These real data are not only the confirmation of something that has already happened, but they must be questioned more and more for various reasons. First, the January data could have been helped by large seasonal adjustments and not be as positive as advertised.
Example: it must be considered that the economic indicators in the United States are given in seasonally adjusted monthly terms, which tend to be more volatile with the change of year. And that this year in particular, due to changes in seasonal behavior, they would become especially unreliable as an indicator of underlying trends.
If we look at the case of retail sales, which contracted in November and December, and instead showed a surprisingly strong increase in January, at 3% month-on-month, it could be argued that the data is not so good, because it responds to a seasonal change that we will not see reverse until March. The explanation in ‘román paladino’ is that the reduction in spending in November and December was not such a bad sign for household consumption, but was explained because Christmas purchases had been brought forward, due to fears of product shortages and promotional sales; And after this change in behavior, the January data is now deceptively strong when compared to December. A less misleading picture would come from looking at the three-month averages, which leaves us with retail sales that are still rising, but already below the pace of most of last year, and even falling moderately if adjusted for. inflation.
Secondly, data that is particularly relevant for monetary policy decision-making is that of the labor market: in January applications for unemployment benefits are still at historically low levels, and it continues to have many more job offers than people who they seek employment.
In fact, in January the unemployment rate fell to 3.4%, a level that had not been seen since 1969. Note, it must be understood that the unemployment rate has become a less reliable indicator of the rigidity of the labor market due to to the increase in workers who have left the workforce with the pandemic. Since February 2020, the number of people not in the labor force has risen to 5 million, far exceeding the 1.4 million increase in the labor force. Thus, given the labor shortage, it is normal that despite a deterioration in the economic outlook, many companies are reluctant to lay off workers. Therefore, a characteristic of this labor market is that companies are choosing to reduce the hours of work of employees rather than increase layoffs, so there may be a recession with fewer layoffs than in previous cycles.
I leave the issue of inflation for a better occasion, but the ‘soft data’ indicates that fewer and fewer companies report that the inputs of services they buy are increasing in price itself, and with respect to the manufactured goods they acquire, the number of companies report that they go up and they go down. Conclusion, wholesale price tensions are easing.
Therefore, the Fed can soften its message of monetary tightening sooner than expected, I say this because they are better economists than me, and as you have already argued, the strength of the economy and the labor market is substantially less than what is apparently shown by the indicators known in the last weeks. And in any case, they are still retrospective data and, as he pointed out, not very robust, which can lead to wrong political decisions. But don’t worry, in Europe we have something similar in the data, but I don’t think the president of the ECB takes this type of argument into account.
