All that's happened since August I think can be boiled down into two main developments: the near-term outlook did brighten considerably, but the longer-term outlook has darkened.
The 2022 recession never came; and the inflation that felt like a recession has diminished substantially, especially given prices for frequently purchased staples like food and gasoline. Pump prices not only plunged but have managed to avoid rebounding again (with concerns about China's Covid lockdowns now keeping prices at bay). The cost of chicken breast has meanwhile plummeted 70% since June!
The GDP numbers show the economy is still expanding, and the jobs report just last Friday showed a solid 263,000 rise in payrolls last month and a historically low 3.7% unemployment rate. Even better--this all means Americans are finally coming out ahead in terms of their earning power. "Nominal wages have matched or exceeded inflation for five straight months," Aneta Markowska of Jefferies noted on Friday.
It's exactly the "goldilocks" scenario Markowska and I wryly discussed on air over the summer that seemed likely to pan out this autumn. The trouble is, everyone senses that trouble is brewing ahead. And I can't say they're wrong about that. The longer-term outlook has darkened, if you look to the signals the financial markets are sending.
Most troubling is that the "real" yield curves are also now inverted--and by the most in decades. If you take the current 10-year Treasury yield (roughly 3.5%), it's now about 1.2 points below the one-year Treasury bill rate of 4.7%. Inversions between these two measures have happened eleven previous times since the mid-1950s, as MKM's Michael Darda keeps emphasizing, with ten signaling a recession was coming and the eleventh followed by a near miss in 1966 when the economy still slowed sharply and the Fed had to slash rates.
Darda thinks the Fed ought to be slamming the brakes here--to what extent, I will ask him on "The Exchange" at 1 p.m. today. It's worth highlighting his current dovishness in particular because he had been one of the most hawkish Fed-watchers over the past couple years, warning they weren't doing enough to stop inflation from spiking. Now, he thinks they're once again behind the curve, paying too much attention to lagging gauges like the actual inflation prints instead of what the markets are signaling.
And perhaps he, or others watching those metrics closely, does have the Fed chairman's ear somehow. Because Jerome Powell in his speech last week suddenly shed his extremely hawkish rhetoric, saying "The time for moderating the pace of rate increases may come as soon as the December meeting." Wow! It was quite an admission--except that market largely shrugged it off. Which means, unfortunately, markets want much more Fed slowing to un-invert the yield curves and perhaps stave off the recession that otherwise looks set to hit sometime next year.
The sticking point in the Fed's willingness to simply stop rate hikes or to even start cutting rates now is the fact that the labor market is still so strong. Markowska notes that 2023 Conference Board data shows salary hikes are expected to be the highest since 2001. The NFIB survey has also shown a spike in firms planning to hike wages in the next three months. The rail dispute that Congress is trying to resolve shows how much power employees have to push for raises right now. The New York Fed's one-year ahead income growth expectations have also surged, in part driven by retirees getting large COLA hikes.
"The Fed is operating under the assumption that there is no wage-price spiral...however, that thesis will be tested early next year," Markowska writes. "We don't see the Fed pausing hikes before the funds rate reaches 5.1%." And, she cautions, the flip-side of higher salaries is lower corporate earnings--a warning point for the stock market, whose recent rebound could hit the rocks as earnings come under pressure next year.
Can the Fed pause while wages are still so strong? Should they? Or will the labor market hit some kind of sudden stop? This is the primary question that needs to be answered.
See you at 1 p.m!
Kelly
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