Will FED Cut Rates in 2023?
We can all agree that inflation remains obstinately high and has become more widespread. Consumer prices began rising significantly late last year in 2021 and have continued in 2022 at an uncomfortable, alarming pace exceeding central banks targets in not only the US but most of the largest global economies.
Containing inflation is a priority so continued monetary and fiscal tightening is most likely needed to tackle inflation and address debt susceptibilities.
Although the recent CPI and PCE reported a deceleration from projections, they are still increasing M/M with CORE CPI at a lower rate this month .3 vs .6 last month. CORE is key. Yes, we have persistent elevated inflation. Per Cleveland Fed forecasting, we are projected to be in 7s% and 5s% Y/Y, respectively, and monthly increasing by about .4-.5%. That is concerning.
Of course, the upcoming CPI reports will provide us with the proper answers as to whether we receive a pause or cut. The data will speak for itself, so the next few reports are critical.
We need to see a consistent pattern before we can conclude that we are making effective progress towards reducing inflation to more agreeable levels. Could this deceleration we are witnessing lead to deflationary economic conditions? Anything is possible so we remain open to that possibility as well.
The FED has work to do.
In my opinion, the Labor market holds the key. We have a tight labor market as demand for workers exceeds supply. Nominal wages have grown significantly. Wage inflation fuels nominal spending which continues to drive nominal demand in a loop which further facilitates entrenchment. That seems to already be occurring in wage and price settings affecting financial and household decisions. Therefore, Increased tightness in labor markets is placing pressure on consumer prices. We need to reduce the nominal spending at the source so I believe it is necessary to soften the labor market otherwise they will keep chasing each other. However, the question is how much softening is needed for stability.
As we look deeper from our manufacturing b2b view, we see skills set imbalances as a key driving factor. Expectations have changed significantly on both sides. Higher turnover & seeking expenses for businesses due to these mismatches coupled with a time intensive sifting process from “too many” mismatches with the qualified applicants getting lost in the mix.
How much to soften? Let’s look at the data.
The unemployment rate is only 1 data point.
Very Low Unemployment at 3.7% and NFP at 263k new jobs but are those numbers really reflective of what is going on? Back in August I reported and tweeted about the disparity between the household and establishment surveys. They utilize different methods in data collection and being a skeptic, I looked deeper. There has been a rise in multiple jobholders since early 2021. In the household survey there is no duplication but with establishment survey (which is what is used to calculate the jobs count) employees working at greater than one job and appearing on more than one payroll are counted separately for each appearance. So, are the job numbers as high as reported or much less? Is this noise or are these inconsistencies worth further study?
Recent initial claims are at the lower end plus there are data lags and delays for these claims. For softening there should be a rise and studies demonstrate for economic weakness these should exceed about 400k.
Although the recent JOLTS number “changed little” it is inarguably still high. 2 rate of job openings ratios that are effective measures to examine the tightness of the labor market & can assist us in explaining price and wage pressures are Beveridge Curve (job openings to unemployment) and fill rate (job openings to hires) both suggesting less softening may suffice with fill rate suggesting the least. These patterns all imply that an elevated number of people taking jobs are not coming from the unemployed. As I said before, the number of multiple job holders have been increasing since early 2021. (Both ratios very high with fill rate less above its trend)
A concern for the labor market is that between tightening liquidity and higher rates as well as other aforementioned employment data possible inconsistencies, unemployment can trickle upward at an increasing pace, and it may be very difficult to stop once it starts. Therefore, in my opinion rate cuts are a remote possibility very late next year or early 2024 if the labor market weakens significantly coupled with a moderate to severe recession.
Nonetheless, we should continue to experience significant pressure on the labor market with declining negative productivity and low labor force growth even with about 2.8% real growth.
As of now, Fed terminal rate is in 5s% mid next year with Powell saying over 5% by Sept. As Bullard said we should be between 5-7%. It is plausible. Studies demonstrate that rates should be higher than CPI by about 1.5-2% to break the back of inflation. Therefore, the FED could raise rates more than currently expected and leave them there longer than one might expect. This is all dependent on the next few CPI prints as we need to see a consistently declining pattern.
So, we are currently at 375-400. If we get 50 bps in dec to 425-450 and then another 25 in feb to 450-475. So we have about another 50-75 bps to get to 500-525 bps.
Do we know now if that will suffice to get the job done? No. I always keep an open mind as things can and will change.
Per Powell at last FOMC, too premature to speak of a pause. We are at low end and have ways to go.
His sole focus is to bring down inflation and it is warranted.
Per Powell, (3 lessons learned from 70s-80s):
1. It is the Central Banks responsibility to deliver low and stable inflation. Achieve price stability
2. We need to avoid Entrenchment & the anchoring of high inflation. A real issue that we must avoid to prevent a prolonged effect.
3. Keep at it until it’s done.
He also discussed 3 goals and we aren’t there
1. Below trend growth
2. Softening labor market – supply/demand imbalances. Many skill mismatches.
3. Clear evidence of inflation headed to 2% – does not seem likely with current prints & projections
Their tool is to raise the fed fund rate through tightening monetary policy (or taxation through their fiscal policy and no one wants that)
Could inflation possibly remain greater than 2% and in a range of 3-4%? Only time will tell us that answer, but it is plausible.
Pain now to prevent worse pain later on.
The FED has work to do.
We should remain aware that persistent elevated inflation could require rate hikes greater than currently anticipated, further tightening of global financial conditions, and increasing risks of a sovereign debt crisis for susceptible economies. Bringing down inflation is a key policy priority. The ultimate goal and priority in most economies, including US is to ensure price stability while bringing down debt levels and protecting those most vulnerable without “breaking anything” such as the labor market.
Therefore, with all the foregoing, I maintain that rate hikes should continue with a slow down near term and then most likely weaning off and then a pause. It is too premature in my opinion to discuss a pivot and/or cut yet at this time. I prefer to plan for 6 mo or so ahead and as of right now I could anticipate a pause possibly Q2-Q3 2023. Let’s focus on that part first.
However, this recent pattern of deceleration could materialize to deflationary economic conditions.
OR within 12 months potential employment challenges can surface which is a possibility with over tightening and then a surge in claims & unemployment accompanied with a moderate to severe recession then rate cuts are a possibility late next year 2H2023, possibly Dec or early 2024.
We remain open to all possibilities during this time of uncertainty as new information becomes available.
Of course, this can change quickly if the data changes but so far it has “not significantly enough”. We will see with next few CPIs. I always keep an open mind and remain flexible. We are data dependent so as new data comes in, the moving parts keep moving and changing their synergetic outcomes. The only certainty is uncertainty.