Written by: David Waddell | Waddell and Associates
Bottom Line:
The Fed has two congressional mandates: price stability and full employment. Currently, inflation retreating and the labor market expanding have the Fed in good standing. However, historically tight monetary policy and increasing softness in the labor market requires more attention and communication from the Fed. Being late to increase rates aggravated inflation, being late to decrease rates could initiate recession. Next week’s Fed meeting marks the first where policy emphasis should subtly shift from fighting inflation to avoiding recession.
The Full Story:
The US Central Bank has two congressional mandates. First, maintain stable prices. They must pursue monetary policies that limit inflation/deflation and price volatility. The Fed self-designated a 2% inflation rate as “price stability”. Unfortunately, though the Fed has set that target, reality rarely complies.
Inflation rates vacillate, leading to vacillating policy rates. In example, the combination of COVID stimulus and economic shutdown policies created historic demand/supply imbalances across the economy, leading to high inflation, which required a major monetary policy response from the Fed. Here, we chronicle inflation and the Fed’s effective policy interest rate over the last couple decades:
Clearly, policy moves lag inflation moves. Most recently, inflation hit nearly 9% before the Fed’s policy response began. Since then, inflation has reversed, but Fed policy has not. Should it? Maybe. Let’s simplify this chart by subtracting the Fed’s effective policy rate from the inflation rate:
The Fed has set the current policy rate at 5.5%. The most current consumer price index inflation rate reads 3.2%, placing the policy rate nearly 2.5% above the inflation rate. Per Powell’s most recent commentaries, he views the current policy rate as “sufficiently restrictive”.
Indeed, over the past 20+ years, policy “restriction” at these levels preceded recessions. Should these restrictions prove too onerous, the Fed risks violating its second congressional mandate—maintaining full employment.
On Friday, we received the November Jobs report. Employers added 199,000 new workers vs. the 190,000 expected, and the US unemployment rate dropped from 3.9% to 3.7%. Additionally, wages grew 4% over the past twelve months.
Payroll growth, wage growth and unemployment levels below 4% depict a labor market well within the “full employment” zone. However, by other measures, the labor market appears less full. While weekly initial jobless claims (layoffs) remain minimal, continuing claims (accumulated layoffs without new jobs attained) have risen recently:
Additionally, according to the Job Openings and Labor Turnover Survey from earlier in the week, the number of job opening has fallen significantly recently:
Also, while the economy added 199,000 jobs in November, over 50,000 were returning UAW and SAG strikers. Additionally, government and healthcare accounted for 150,000. Private sector employers appear less confident. For instance, while leisure and hospitality added 40,000 jobs, consumer-facing retailers eliminated 40,000 jobs.
Outside of sectors subsidized by the government, job creation has stalled. Economic growth for the quarter has also downshifted significantly. The Fed’s “GDPnow” tool predicts 1.2% growth for the fourth quarter and the Citigroup Economic Surprise Index nears zero:
These labor softening developments warrant attention and public recognition from the Fed.
While 2023 consisted of higher-than-average inflation readings and reactionary rate hikes from the Fed to fulfill its “price stability” mandate, 2024 may consist of lower-than-average employment readings and reactionary rate cuts from the Fed to fulfill their “full employment” mandate. The game has changed.
Related: The Retail Runaround for 2024