Exactly three weeks ago today, the Fed came out with a "surprisingly" large 75-basis-point rate hike. And it seems to have finally broken the back of the inflation trade, with early signs it may also help bail out the U.S. consumer.
In the past four weeks (which includes the market's anticipation of the super-sized hike that was coming), commodity prices have plunged. Since June 8th, as Bespoke Investment Group points out, oil prices have plunged 22% and copper has dropped more than 25%. The energy sector--which was up 40% at one point this year--has now fallen nearly 28% from its highs, even more than the technology sector has corrected. Crazy!
As commodity prices have fallen sharply, so too have the market's inflation expectations. Expected inflation over the next five years is now at its lowest point year-to-date, at about 2.5% annually, versus over 3% at the same point in early June, pre-Fed meeting. Expected inflation over five to ten years has sunk from almost 2.5% to 2.09% in the same timeframe--putting us almost exactly back to the Fed's 2% long-term inflation target.
But because many of these market moves--like the drop in copper or the 10-year Treasury yield--are the same kind of moves that predate recessions, this is all being taken as a sign of a policy mistake, not a success story. That narrative made sense in 2007, when we had a housing bubble but relatively dormant inflation. Today, however, we need these kind of market moves to indicate the Fed is successfully tamping down the inflation that has eroded real growth in the economy.
The two data points that most spooked the Fed into its overdue mega-hike last month were the surprisingly high CPI report the previous Friday, and the consumer sentiment report released later that same day. Sentiment not only hit a record low (for a series with a 75-year history), but consumers' inflation expectations rose further, up a tenth to 5.4% for one year, and up three-tenths to 3.3% for five years. That plainly showed the risk of inflation becoming "embedded" in the consumer psyche, and more difficult for the Fed to fix if it didn't act swiftly and aggressively.
But remember--that was back when oil prices were near their highs. The highest average national gasoline price literally occurred on June 14, the day the Fed's meeting started, at $5.01 a gallon, according to AAA. The price has since dropped to $4.78, and after the mini-crash we saw in energy prices yesterday, could be headed significantly lower from here in the weeks to come. "In the days and weeks ahead we're going to see hundreds, nay thousands, of stations falling back under $4 per gallon," tweeted GasBuddy's Patrick DeHaan.
That is hugely positive news for the U.S. consumer. Falling gasoline prices are perhaps the most visible and frequent price squeeze on households. Falling grocery store prices would be even better, and the recent plunge in commodity prices at least points towards hope on that front. In other words, in three short weeks the Fed has managed to reset the market's long-term inflation expectations back to their 2% target, and made a huge move in the right direction on the consumer front as well.
And the urgency of their need to move was underscored in the data today that showed the last major piece of the inflation puzzle--the labor market--still remains in dangerously overheated territory. The number of U.S. job openings failed to drop sharply, and was still well over 11 million as of May, which will keep upward pressure on wages and inflation in the months ahead.
There is simply no sign of a sharp weakening in the labor market, even in more recent weeks. Jefferies looks to activity on indeed.com, whose postings still point to "well above 11 million" job openings in June. Weekly jobless claims have also remained firmly low, meaning Friday's official monthly jobs report is unlikely to reveal too much new news on that front.
In fact, "there is no convincing evidence that the Fed's actions have had any material impact on labor demand," wrote Aneta Markowska of Jefferies this morning. "More importantly, labor demand is not cooling enough to ease wage pressures." There is no sign that the quits rate is falling back to normal, or that layoffs are picking up, she notes; "Thus, the balance of power remains firmly tilted toward labor."
All of which means that the upward pressure on prices in the service and transportation sectors may persist until or unless the Fed tightens policy even further to fix the imbalance. Those who are already saying the Fed's big hikes are causing a recession, or were a big mistake, or are certainly over now--well, I wouldn't be so sure. The good news is, the super-sized hike last month is at least one big step in the right direction.
See you tomorrow!
Kelly
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