In Focus: Fed's mildly restrictive policy may not be restrictive enough.
The compelling case for higher interest rates - even after a potential rate hike pause.
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theSTATreport^ is home of the “In Focus” series. A data-driven, in-depth, evidence-based series about the US Fed, FOMC, and US Economy.
In this article:
Why a rate hike pause may be followed by additional hikes.
Insightful visuals relevant to FOMC decision making.
FOMC Cheat Sheet. Compare changes in key recent stats vs the stats at last FOMC meeting date.
Informative Fed Watch Research
Think Ahead — Reflective thoughts to keep in mind.
The Fed Funds Rate has increased 500 bps, from March 2022 through May 2023 and now exceeds 5% which is generally viewed as restrictive.
What has been accomplished by the Fed by increasing rates 500 bps? So far, not much.
The economy has momentum. Atlanta Fed GDPNow at 1.9%.
Labor market is still way to tight to be consistent with the Fed’s 2% inflation mandate.
The ratio of unfiled jobs to unemployed workers remains far above the 1-to-1 level that Powell has indicated would be about right. April's surprise surge in job openings indicates the Fed has more to do to sustainably rein in inflation. Vacancies per unemployed worker increased to 1.78 in April, from 1.67 in March.
The Job Openings and Labor Turnover Survey showed job openings rose to 10.1 million in April, from 9.75 million prior. These openings may prove temporary as other indicators show the labor market slowly cooling.
The job openings can be traced to retail trade (+209k), health care and social assistance (+185k), and transportation and warehousing (+154k).
Unemployment rate of 3.4% is far below what is needed for 2% inflation.
Wage inflation, depending on which measure is being used, ranges between 4% - 6%. Powell thinks wage inflation needs to be 3% to be consistent with 2% inflation.
This results in higher consumer price inflation, which the YOY% change in the core personal CPI, has been stuck during the past six months.
The Fed is holding trillions of dollars of treasures and MBS that it purchased during the pandemic. It’ll take a couple of years to the get the balance sheet down to a level in which it is no longer adding accommodation.
YTD and most recent week change in Fed Assets.
Distressed regional banks account for less than 5% of total US banking assets. Their main challenges are higher funding costs and lower net interest margins, not bad loans. The case, as many FOMC speakers have stated, that regional banking stress will substitute for additional rate hikes, appears to be in question.
Think Ahead — Reflective thoughts to keep in mind.
So now what? FOMC speakers appear to be more split between raising rates again at the next meeting vs those who are suggesting a pause is in order to wait and assess the impact of the recent rate hikes.
The key decision makers - Chair Powell, Board Vice-Chair Philip Jefferson and FOMC Vice-Chair John Williams - their view may prevail at the June meeting.
Labor market and wages will be key drivers to assess how much progress the Fed is making toward their 2% inflation objective.
If there is a pause of rate hikes at the June meeting, that pause, might be short lived.
It’s not in the Fed’s interests for financial conditions to loosen in a significantly impactful way (stocks go up and bond yields go down). That may be why some FOMC members may be using the language of “skip” vs “pause” within their communication. As past pause’s have often been followed with a loosening in financial conditions. Loosening financial conditions would be counterproductive to their efforts to create slack in the labor market.
There is a risk of tightening to much. Policy can work with long and variable lags. Will further hikes eventually lead to a recession in which the unemployment rate is higher then what is needed to contain inflation?
Banking stress may not be adding to similar effects of a more restrictive policy to the extent that may have been potentially previously anticipated.
The FOMC may not be concerned with how long it will take to get back to their 2% inflation mandate and may be prioritizing that their policy is putting the US economy on a sustainable path to their 2% goal. So long as inflation expectations stay anchored at a level they will accept.
If it is believed that the Fed needs to push up the unemployment rate by a meaningful amount, how logical is it that a recession can be avoidable if that does materialize? Based on the Fed’s forecasts, they think the unemployment rate needs to rise by at least 1%. Every time since WWII the unemployment rate increased by 1%+, we had a recession. 12 out of the last 12 times. I’ll do a post on the Sham rule, it’s history, and where we are at pertaining to the state level with unemployment.
Fed Strategy
Bring rates up to moderately restrictive level and hold them there for as long as it takes to ensure inflation will fall back to the bank’s 2% objective. This will eventually create slack in the labor market, which will with time, show up in the inflation statistics as lower inflation.
As more time passes, we have discovered that the required level of restrictive policy is a little higher than anticipated.
That means - rates may be higher for longer.
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