Nothing about yesterday's Fed decision and press conference sat well with me. I know I should respect the market's "verdict" -- the Dow started jumping as soon as Chair Powell ruled out a 75-basis-point rate hike, and closed up a whopping 900 points -- but I actually see it as part of the problem.
The main issue, I think, is the widespread confusion about inflation right now. The typical person goes I get it, we had a pandemic, prices spiked, and we have to give it some time for prices to come back down. If the Fed slows the whole economy to fix that, they're making a big mistake. This is a common view even on Wall Street. But the inflation we're facing now is a broad inflation driven by policy stimulus and the super tight labor market, not a lingering byproduct of the scramble for toilet paper two years ago.
Think about it. One viewer kept arguing with me on Twitter yesterday that the gasoline price spike is because of supply shortages caused by government policy and the war on Ukraine, and hence the Fed shouldn't tighten in response to it. Then why have all commodity prices been spiking this year? Why have the prices of corn, wheat, soybeans, cotton, orange juice, rice, copper, iron ore, aluminum all been jumping and in many cases, breaking out to new highs?
The core issue is demand--the global policy stimulus from both central banks and governments created a massive wave of demand relative to the economy's typical capacity. As Greg Ip said on our show earlier this week, this is why we keep seeing supply shortages cropping up. It doesn't help when a war breaks out, or China goes into lockdown again. But it's not the core reason why we're in this situation.
"Too much demand" has even now resulted in too much demand for jobs and workers. The number of job openings in the U.S. shocked everyone this week when it jumped to a fresh record high of 11.5 million. That's nearly two openings for every unemployed worker in America. The total number of filled and available jobs now surpasses the total number of workers and unemployed people by 5.6 million, according to Goldman Sachs--the biggest gap ever. There's literally not enough people.
The second big issue with this whole situation is that to most people, "too much demand" sounds like a good problem to have. But it's not. It means that if the economy can't produce more, prices for the same stuff simply go up. People aren't coming out ahead--their dollars are simply losing value. If you've experienced "shrinkflation" lately at the grocery store, or sticker shock at a restaurant, you know what I'm talking about.
And we got some unfortunate confirmation this morning of exactly this dynamic playing out. U.S. productivity, or output per worker hour, actually dropped last quarter. It's now 0.6% lower than it was in the first quarter of last year. Meanwhile, compensation per hour soared 6.5%; total unit labor costs (including benefits and such) are up a whopping 7.2% year-on-year; and yet that's still trailing the inflation rate. So compensation in real terms dropped for the second quarter in a row, meaning workers correctly feel they're not coming out ahead.
I think the Fed needs to come clean here. This isn't about supply chain problems, or the war on Ukraine. This isn't about trying to achieve a "soft" or "softish" landing, whatever that means, for markets and the economy. The U.S. is experiencing a massive inflation shock, and fixing "excess demand" is exactly what the Fed is here to do. If that means a recession or further stock-market selloff right now, so be it--and they should tell us that. As Ethan Harris cogently argued on our show yesterday, it's better than letting the inflation problem worsen and potentially causing a much deeper recession in the future.
And Powell actually sounded like he was about to do just that yesterday. He began his press conference by saying, "Before I go into the details of today's meeting, I'd like to take this opportunity to speak directly to the American people. Inflation is much too high, and we understand the hardship it's causing, and we're moving expeditiously to bring it down." And as soon as those words were out, the Dow dropped 200 points.
But he backtracked as the press conference wore on. Powell ruled out using a 75-basis-point hike to raise rates this year, sparking the massive stock market rally. "If the Fed wants to 'expeditiously' tighten policy and financial conditions, not sure Powell should have removed the speculation of 75bps," tweeted Kathy Bostjancic of Oxford Economics.
And sure enough, look at what's happening now, this morning. Yields are spiking, and stocks are selling off sharply. "The bond market is sending a message that Powell is too dovish," Andrew Brenner of Natalliance wrote to clients.
What do I think? I think the markets are smart enough to know that "going easy" to try and achieve a "soft landing" risks making a bigger hash of things. Stocks may well keep selling off if fighting inflation risks a near-term economic downturn--but we'd get one anyway if inflation keeps outstripping the economy's productive capacity.
Plus, going too soft on inflation simply means more years of having to fight it. Recessions aren't great for stock returns, but inflationary decades are even worse.
See you at 1 p.m!
Kelly
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