Thoughts From The Divide - Dilemma

While Fed speakers continue to ride the “blip?” train, Jerome Powell had the opportunity to offer Congress the benefit of his thinking this week. Amid his usual comments regarding tightening financial conditions and the Fed’s unwavering commitment to bring down inflation, the chairman gave rate markets something to think about by saying that strong data meant that “the ultimate level of interest rates is likely to be higher than previously anticipated”. His comments included saying that “if – and I stress that no decision has been made on this – but if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes”. So higher for longer. Markets took the ball he offered and ran with it, now pricing in a roughly 75% chance of a 50 bps hike at the meeting later this month. 

Mohamed El-Erian argues in a recent article that the more there is “undue volatility” around Fed communication, “the greater the risk of economic and market accidents”. We have discussed “economic accidents” in the past in our discussion of “accelerative oscillations” (see Julian’s recent interview on MacroVoices). But the President of Queen’s Cambridge is right to point out the increasing risks of “market accidents”. Higher rates (for longer) are often found at the scene of the crime. What’s more, El-Erian says that the Fed now faces a dilemma: “either validate the market move and, in the process, negate in an embarrassing fashion the forward policy guidance provided just a month ago, or stick with that guidance and fall further behind in the battle against inflation”. 

GM announced today that it was offering buyouts to white-collar employees to cut “structural costs” (that’s no way to talk about “human capital”). The Fed will be pleased to hear that GM is not alone in reassessing how much human capital it needs. According to the latest Challenger Report, job cuts are spreading across sectors, which admitted that while “the overwhelming bulk of cuts are occurring in Technology”, job cuts occurred in all of the industries the firm tracks, something not seen since 2013. So, it’s working? 

Not necessarily. Wage hikes are happening all over the place. Japan’s largest union group negotiated “for average wage hikes of 5.28%”, while Toyota “announced it would accept a union demand for the biggest base pay hike in 20 years”. Federal employees could see a similar pay raise if the White House follows up with a rumored proposal of “a 5.2% raise for federal employees”. And airlines are again making a splash: American Airlines “is prepared to match Delta’s pay rates and provide American’s pilots with the same profit-sharing formula as Delta’s pilots”.  

The New York Fed’s Liberty Street blog explained that “the PCE price data released for January have shown a broad-based resilience in inflation persistence”.  

Meanwhile, following the release of the JOLTS data, Employ America jumped into the “divergent story” that job openings are telling in comparison to “other labor market indicators, such as quits, hires, and employment-based measures”, arguing that “the Fed needs to pick a side” and decide if “it is going to continue emphasizing the job openings data” or if it will take heed of the “mounting pile of evidence that the labor market, while strong, is cooling and heading back towards its less inflationary pre-pandemic state”. 

As an aside, if we follow the logic of this Bloomberg article, companies don’t need the excuse of higher wage costs to pass on higher prices. In the current conditions, any excuse will do. All this helps explain why J Powell felt obliged to wear his Rambo undershirt for the JEC testimony. 

P.S. Last week, we briefly touched on the current state of play in European energy markets. This week, Javier Blas, whose analysis we’ve highlighted before, discussed “the new European energy normal” and how “the new energy backdrop” means that European companies likely “face a long-term loss of competitiveness and the region faces more entrenched inflation”. This kind of thing was often called “supply side” problems when we were young. But it can be surprisingly hard to distinguish supply-side problems from terms of trade shifts. In the meantime, France’s nuclear reactors are once again making headlines for maintenance issues following the detection of “a new crack” courtesy of “additional stress corrosion”, and Britain “called on a new back-up coal fired reserve to generate power for the first time” to maintain operational margin amid strikes in France affecting power generation, “conditions of low wind” and facing “freezing temperatures”. 

P.P.S. Olivier Blanchard and Larry Summers had a debate on the “future of interest rates” (including some talk on moving the Fed’s inflation target up from 2%), which can be found here. Let’s call it “shaping the battlefield” for the future.