Fed’s Jerome Powell Braces for Longer Inflation Fight Amid Hiring Surge Process of lowering inflation to goal of 2% is likely to take ‘quite a bit of time’

A government report Friday that showed hiring accelerated in January was “certainly strong—stronger than anyone I know expected,” Mr. Powell said Tuesday during a moderated discussion before the Economic Club of Washington, D.C. “It kind of shows you why we think this will be a process that takes a significant period of time.” (…)

The process of lowering inflation to the Fed’s goal of 2% “is likely to take quite a bit of time. It’s not going to be, we don’t think, smooth,” Mr. Powell said. “It’s probably going to be bumpy.”

The expectation that inflation “will go away quickly and painlessly…is not the base case,” he added. “The base case for me is that…we’ll have to do more rate increases, and then we’ll have to look around and see whether we’ve done enough.” (…)

“We’re going to react to the data,” he said. “So if we continue to get, for example, strong labor market reports or higher inflation reports, it may well be the case that we have to do more and raise rates more than has been priced in.” (…)

Mr. Powell has for the past three months justified continued interest-rate increases by noting still-tight labor markets, elevated wage pressures and high inflation for labor-intensive services. “We’re not seeing disinflation there yet, and that’s going to take some time,” he said Tuesday. “We’re going to need to be patient.”

Later, he returned to that component of service-sector inflation failing to slow down this year as one of the most concerning developments facing the Fed. “That’s what I worry about,” he said. (…)

Mr. Powell also modified his qualification of the labor market, from “very, very strong”, used in the past several months to “extraordinarily strong.”

He also said:

• “the Fed hasn’t yet achieved a sufficiently restrictive interest-rate setting.”
• If the data continue coming in stronger than the Fed expects, then the Fed “would certainly raise rates more.”
• “Shortage of workers feels more structural than cyclical.”
• “That isn’t going to change,” Powell says of the 2% target.
• “My guess is it will take certainly into not just this year but next year” to get to 2%.
• Powell says the Fed isn’t actively considering sales of mortgage securities.

Yesterday, from the NY Fed:

• Inflation Persistence—An Update with December Data

(…) As many sectors continue to experience high price volatility, uncertainty is high resulting in a 68 percent probability band (shaded area) of (3.2, 4.2). However, as the first chart shows, the probability band remains below the standard twelve-month core PCE measure, which in December declined to 4.4 percent.

PCE and Multivariate Core Trend

Sources: Bureau of Economic Analysis; authors’ calculations.
Notes: PCE is personal consumption expenditure. The shaded area is a 68 percent probability band.

Despite the apparent stability of the trend in the last two months, there were notable changes in its composition. The core goods trend subtracted 0.2 percentage points (ppts) from the MCT, while housing added 0.2 ppt. The core services ex-housing trend was essentially flat.

Considering this, the contribution of housing inflation to the increase in the persistent component of inflation from the onset of the pandemic, at about 1.1 ppts, is now more than twice as much as the cumulative contribution of goods and services ex-housing (0.4 ppt each), as shown in the following chart.

Inflation Trend Decomposition: Sector Aggregates

Sources: Bureau of Economic Analysis; authors’ calculations.
Note: The base for the calculations of the contributions to the change in the Multivariate Core Trend is the average over the period January 2017-December 2019.

What this NY Fed’s piece shows is that the trend in core inflation has stabilized below 4.0% with both goods and services-ex-housing contributing equally to the slowdown. Housing remains the inflation villain that everybody expects to become friendly sometime this year.

But the Cleveland Fed, in a Jan. 13 working paper, does not see housing inflation that much friendlier, not even through 2025.

Housing services inflation is projected to decline at a steady rate through late 2024, but then its downward progress stalls out, likely reflecting the sluggish dynamics of rent. During 2025, it settles in at a 4.5 percent pace, before continuing to decline briskly, reaching 3.8 percent by early 2027.

Actually, that paper’s authors would not bet heavily on the FOMC’s recent inflation forecast:

We first present the model projection for core PCE inflation through 2025, along with 70 percent confidence intervals, and the [FOMC’s] SEP [Summary Economic Projections] in Figure 3. Our model projections are conditional on the December SEP path for unemployment.

The SEP projection initially lies above the model’s mean projection, and outside the 70 percent confidence interval. This is because, in our model, the projected 2023 uptick in the unemployment rate in the SEP projection puts downward pressure on all of the inflation variables.

Thereafter, however, the persistence of inflation reflected in our model estimates becomes evident, and progress toward the 2 percent target slows.

Conversely, the SEP projection then continues its steady downward drift. This steady decline moves the SEP projection within the confidence interval, where it remains for most of 2024.

However, thereafter, the SEP projection continues to move steadily lower, so that it moves outside of, and well below, the confidence interval. Hence, from late 2024 onward, the SEP projection is assessed as too optimistic relative to our model’s assessment. Our model forecast is a touch below 2.7 percent by the end of 2025; it does not reach 2.1 percent inflation until several years later. (…)

Our model sees core goods inflation rebounding from -0.5 percent inflation in 2022Q3 to near 0 in early 2024, then slowing to a -0.40 percent pace in 2025.

Non-housing core services inflation is projected to fall to 3.8 percent by the end of 2023, driven by downward pressure from the rising unemployment. Then its downward progress slows so that it decelerates to 3.4 percent by the end of 2025.

Housing services inflation is projected to decline at a steady rate through late 2024, but then its downward progress stalls out, likely reflecting the sluggish dynamics of rent. During 2025, it settles in at a 4.5 percent pace, before continuing to decline briskly, reaching 3.8 percent by early 2027. (…)

We next provide a number of additional inflation projections, conditional on three alternative unemployment rate scenarios: a soft landing scenario, a moderate recession scenario, and a severe recession scenario.

The soft landing scenario, which conditions on the projected unemployment path from the June SEP, has unemployment peaking at 4.1 percent by the end of 2024.13.

The moderate recession scenario conditions on a path for unemployment from 2023Q1 onward that mimics the 2001 recession. For this path, unemployment tops out at 5.6 percent in 2025Q3.

Finally, the severe recession scenario (inspired by the Summers/Ball/Leigh/Mishra assertions) conditions on a path for unemployment from 2023Q1 onward that mimics the 1973 recession. For this path, unemployment tops out at 7.8 percent in 2024Q2, although unemployment averages 7.4 percent over the year.

Unemployment rates in all scenarios, with the exception of the severe recession, are assumed, after 2025Q4, to descend linearly to hit 4 percent by the end of 2029 (or in the case of the soft landing, by the end of 2025).

(…) Notice, however, that once the deceleration pressures ease, progress toward 2 percent slows markedly. Inflation is more persistent than is commonly believed. (…)

Looking ahead, our model projects that inflation only very gradually falls back to 2 percent. Progress toward target is very much influenced by the path that unemployment will take over the next several years.

Conditional on the December SEP median unemployment rate projections, inflation is projected to still be nearly 2.7 percent by the end of 2025, far above the SEP’s median projection of 2.1 percent.

A moderate recession (roughly equal to the recession of 2001) would put inflation at 2.4 percent by the end of 2025; conversely, a soft landing (which we define as the path of unemployment in the June SEP projection) would put inflation a touch above 2.8 percent by the end of 2025.

What kind of recession would it take to hit the SEP projection for inflation, according to the model developed in this paper? We investigate the claim of former Treasury Secretary Lawrence Summers (reported in Aldrick, 2022) and the supporting assessment of Ball, Leigh, and Mishra (2022) that it will take two years of 7.5 percent unemployment from its current low level to bring inflation down to its 2 percent target. We find that one year of 7.4 percent unemployment would accomplish this task.

• Wholesale Used-Vehicle Prices Increase in January

Wholesale used-vehicle prices (on a mix, mileage, and seasonally adjusted basis) increased 2.5% in January compared to December. The Manheim Used Vehicle Value Index (MUVVI) rose to 224.8, down 12.8% from a year ago. January’s increase was driven in part by the seasonal adjustment. The non-adjusted price change in January was an increase of 1.5% compared to December, moving the unadjusted average price down 11.0% year over year.

(…) we initially estimate that used retail sales increased 16% in January from December and that used retail sales were up 5% year over year.

Using estimates of used retail days’ supply based on vAuto data, January ended at 44 days’ supply, down from 56 days at the end of December and six days lower than how January 2022 ended at 50 days. (…)

January’s total new-light-vehicle sales were up 4.2% year over year, with the same number of selling days as January 2022. By volume, January new-vehicle sales were down 18.6% from December. The January sales pace, or seasonally adjusted annual rate (SAAR), came in at 15.7 million, a 4.1% increase from last year’s 15.1 million and up 17.7% from December’s revised 13.4 million pace. (…)

(Bloomberg)

U.S. consumer credit grows at slowest pace in two years in sign of economic worries

The amount of credit consumers used in December rose by a scant 2.9% — the smallest uptick in more than two years — as Americans tightened their belts in response to a slowing economy.

Consumer credit rose by $11.6 billion in the final month of 2022, Federal Reserve data showed. Economists had expected a $26 billion increase, according to the Wall Street Journal forecast.

Revolving credit, like credit cards, increased at a 7.3% annual rate in December. That’s the smallest increase in a year and a half.

Auto and student loans, known as non-revolving credit, rose at a 1.5% pace. That category of credit is much less volatile, but it’s the smallest increase since the early stages of the pandemic in 2020.

• Half in U.S. Say They Are Worse Off, Highest Since 2009

Macklem Says Homeowner Debt Helped Spur Early Bank of Canada Rate Pause

Bank of Canada Governor Tiff Macklem conceded that rate hikes have hit the country’s homeowners hard, saying the impact of higher borrowing costs on consumers is a major reason why he chose to hit pause before the US Federal Reserve.

In an interview with Bloomberg News, Macklem said the central bank needs time to gauge how households and businesses are adapting to higher rates before it makes any further moves.

Canadians “are more indebted today than they’ve ever been,” Macklem said after a speech Tuesday in Quebec City. Although some households were able to build up cash reserves during the pandemic, “extra savings are probably not going to last as long as the higher debt.” (…)

The real estate market will probably soften further before it stabilizes later this year, he said. (…)

Chinese Consumers Hoard Cash After Confidence Takes a Hit Beijing is trying to kick-start growth, but one challenge it faces is Chinese citizens borrowed less and saved more last year and it isn’t clear how long it will take to return to freer-spending ways.

(…) “Confidence has plummeted in the past year,” said Zhiwu Chen, chair professor of finance at the University of Hong Kong, referring to both individuals and businesses in China. “When people are uncertain about the future, their first reaction is to save money.”

When China’s government brought an end to its strict zero-Covid policy and unveiled a series of measures designed to help revitalize the property sector between November and December, stock prices jumped in anticipation of a recovery. But Ting Lu, an economist at Nomura, thinks it will take until the third quarter for consumption to recover to “near prepandemic levels.”

The generation of Chinese citizens who emerged from the pandemic may have similarities to those in the U.S. who came out of the Great Depression, said Li-Gang Liu, head of Asia-Pacific economic analysis at Citi Global Wealth Investments. There could be a long-term shift in their desire to save, he said. (…)

Although the U.S. economy experienced a boom after—and even during—the pandemic, Chinese consumers have emerged from the worst of the crisis with little confidence. This is partly because the Chinese government didn’t pay subsidies to its citizens, as the U.S. and governments elsewhere did, meaning many people who lost jobs and income didn’t have a safety net to fall back on, Mr. Chen said. That experience may have taught people that they need to save more to ensure their security, he said.  (…)

The same survey, which covered 20,000 depositors in 50 cities across the country, asked whether people would prefer to save, spend or invest. Around 62% of the respondents chose saving, 23% picked spending and only about a sixth intended to invest more. In a similar survey in 2019, around 45.7% planned to save more. (…)

China Car Sales Drop Amid Weaker Buying Over Lunar New Year

Overall, passenger car sales in China slumped 38% year-on-year in January to 1.29 million, the PCA data showed. That was down 40% from December and the lowest since at least April last year, when China was in the throes of Covid lockdowns. (…)

A total of 332,000 new-energy vehicles, including pure electric cars and plug-in hybrids, were sold last month, down 48.3% from the month prior and 6.3% lower than sales in January 2022, according to final data released by the China Passenger Car Association Wednesday.

Chinese automaker BYD Co. and US manufacturer Tesla Inc. led the pack, shipping 151,341 and 66,051 cars, respectively. Some 26,843 China-made Tesla Model 3 sedans and Model Y SUVs were delivered to local customers, while 39,208 were exported. Momentum picked up for Tesla in January after another round of aggressive price cuts. The EV pioneer was forced to cut output in December from its Shanghai factory amid muted demand. (…)

The scrapping of a national subsidy on EV purchases at the end of 2022 also encouraged customers to place orders in the fourth quarter. Sales of Xpeng Inc., Nio Inc., and Zhejiang Leapmotor Technologies Ltd. all witnessed drops in January. (…)

How golden is the golden cross?

Usually a good signal, but we have seen poor results as well. Tier1Alpha notes: “This indicator also has a strong history of positive returns after a cross has been made, especially when looking around three months out from the crossover. With that said, there are quite a few examples of negative returns as well, especially pre-2000, and the strength of those returns varies greatly, with the max being 18.94% in 2009 and the weakest return being -13.4% in 1990.”

Tier1Alpha

Refinitiv

• We haven’t seen such a low reading when it comes to people wanting to increase equity exposure. More upside pain in equities? (The Market Ear)
  

JPM

Crypto Absent from Super Bowl Ads

One year after the Crypto Bowl, it’s out with the new and in with the booze for Super Bowl commercials.

Fox, which has broadcasting rights this year, has sold all of its advertising airtime for Super Bowl LVII, sticking with the old reliables of beer and snacks, with crypto nowhere to be found.

Back to basics, so to speak…

Households Burn Through Last of Pandemic Savings The combination of high prices and the end of pandemic relief programs is eating into household savings.

Americans have spent down about 35% of the extra savings they accumulated during the pandemic as of mid-January, according to an estimate from Goldman Sachs. By the end of the year, the company forecasts that they will have exhausted roughly 65% of that money. (…)

His team at Goldman Sachs estimates that the monthly saving rate will rise modestly by the end of the year, to about 4.5%. (…)

Among Bank of America customers with a household income below $50,000 a year, the median balance in checking and savings accounts peaked in April 2021, according to an analysis by Bank of America Institute, a think tank within the bank. Between then and November 2022, that figure fell 36%, versus 14% for customers with a household income between $100,000 and $150,000 a year.

Still, across all income brackets, median balances remained elevated compared with shortly before the pandemic, in February 2020. (…)

Need proof of excess savings?

• Tom Brady Retired on a Beach. Now, an Auction for a Jar of Sand Nears Six Figures. Auctions for beach sand said to be from the exact spot the NFL legend filmed his retirement video are popping up on eBay

(…) “Tom Brady’s exact retirement spot—Bottled Sand,” says an auction announcement posted on eBay. As of Sunday, the auction has 119 bids, with the top one currently at $99,900. The auction for this jar ends Feb. 12. (…)

“You will be owning the very land the GOAT retired on,” the ad says, referring to the acronym for “greatest of all time.” (…)

While the seller has only put one jar up for sale on eBay, competitors have joined the game.

At least seven other similar eBay ads have appeared on the auction site. Although there is no way to confirm the sand is from the beach where Mr. Brady shot his video, the jars have been listed at prices ranging from $100 to $24,000. (…)

Fed loan officer survey finds tighter loan standards, reduced demand

Lending officers at major banks told the Federal Reserve that in the final three months of last year they tightened standards and saw reduced demand across a wide array of business and consumer credit fronts.

The Fed reported Monday in its January Senior Loan Officer Opinion Survey that the threshold to get credit rose for commercial and industrial firms, as well as commercial real estate borrowers. At the same time, these prospective borrowers reduced their demand for loans.

On the consumer front, survey respondents said that real estate and related lending standards got tighter amid declining demand for the same period. The same dynamic played out for auto, credit card and other types of consumer lending.

The survey also found that the trends that played out across bank lending in roughly the final quarter of 2022 will dominate 2023. “Banks, on balance, reported expecting lending standards to tighten, demand to weaken, and loan quality to deteriorate across all loan types.” (…)

The latest data points to a softening economy. “There were unfavorable changes across many details” of the survey, said Daniel Silver, an analyst at J.P. Morgan, who added the data “looks consistent with an economy that is weakening.” (…)

Fed’s Bostic Says Higher Peak Rate on Table After Jobs Blowout

(…) The Atlanta Fed president, who doesn’t vote on policy this year, said officials will need to understand if the jobs report was an “anomalous reading” in which case he would be “inclined to look through this a bit.” (…)

Anomalies in the January NFP report are numerous (from various sources including my own research):

• Something is happening to the data here in January. Since 2020, it has consistently lined up as a huge month for the payroll data: +334k in 2020, +494k in 2021, and +364k in 2022. And now +517k in 2023. The month of January has somehow managed to line up as 6x stronger than the average for all the months over the past three years.
• The biggest anomaly, perhaps, was that a 471k plunge in the retail sector translated into a +30k seasonally-adjusted run-up, the best number since August — even though retail sales have slid in three of the past four months.
• In January, the BLS adjusts for the new population count. Allowing for this adjustment (+954k last year), and putting the companion Household survey on a comparable footing as the Payroll data, employment only rose +44k in January.
• Average hours worked jumped in January (although not in the Household survey), inconsistent with the sharp increase in part-time employment.
• Full-time jobs accounted for only 54% of all new jobs in January. In fact, full-time jobs are down a cumulative 166k since June 2022 and have not increased at all since March. Historically not a good sign:

US full-time and part-time workers (millions)

Source: Macrobond, ING

• Services employment jumped 471k in January (91% of the total increase). Yet, the S&P Global Services PMI remained very weak in January, signalling “a solid contraction in business activity across the US service sector” (…) and “the pace of employment growth slowed further amid reports of cost-cutting efforts”. True, the ISM-Services said otherwise but its employment index was unchanged with 20.4% of services industries reported higher employment and 24.6% reporting reduced employment.
• The ISM also said that 10 services industries reported growth in January, down from 11 in December, 13 in November and 16 in October. Yet, its PMI index is up during that period! Meanwhile, S&P Global’s Services PMI is down and in contraction territory.
• We know that the ISM survey favors the largest companies while the S&P Global survey is more economy-weighted. It so happened that the ADP jobs report for January highlighted that small business employment dropped 75k in January, its fourth consecutive decline.
• And the NFIB small business hiring intentions was at 19% in January versus 20% for the six-month average. No change!
• Finally, there is the Homebase employment data, a labour scheduling and time tracking tool used by tens of thousands of local businesses that are often individually owned and primarily consist of restaurant, retail and personal services – so reflect the experiences of businesses that won’t be tracked by the larger survey organisations.

Homebase number of workers versus median for the period Jan 4- Jan 31 2020 (% difference)



                                                                                                                                                             Source: Macrobond, ING

Will Wilson win (again)?

Morgan Stanley’s macro guru Wilson reminds us about forward EPS growth that went negative last week. He writes: “…This has only previously happened 4 times over the past 23 years. In each prior instance (2001,2008,2015,2020), equities have faced significant price downside associated with the shift from positive to negative earnings growth…historically, the majority of the price downside in equities comes after forward EPS growth goes negative.” Earnings recession is basically not priced in according to Wilson. (via The Market Ear)

MS

Here’s a variant using the Rule of 20 Fair Value [trailing EPS x (20 – inflation)]. Fair Value (red) is influenced by trends in trailing 12-m EPS and inflation. When the S&P 500 is above/under the Rule of 20 Fair Value, it means overvaluation/undervaluation but trends in EPS and inflation are meaningful for the index cyclical direction.

Here’s a snapshot since 1999. Trailing EPS peaked last October at $222.37. They are now $221.88. If analysts estimates stand, EPS should decline to about $219 after Q1’23 and around $216.5 after Q2, a small 2.6% decline from the peak. At 5% inflation, the R20 Fair Value would be 3250. At 4%: 3465. At 3.0%: 3680. Again, assuming current estimates hold.

JPMorgan’s Kolanovic Calls Latest Stock Rally a Bear-Market Trap

JPMorgan Chase & Co. strategist Marko Kolanovic reiterated Monday that investors should fade last week’s Federal Reserve-induced stock-market rally, arguing that the US economy’s disinflationary process could just be “transitory.”

Kolanovic sees the first three months of the year likely marking an “inflection point in the market,” with an air pocket during the second and third quarters, he wrote in a note to clients. That will be followed by renewed deterioration in fundamentals through the end of the year since the central bank will likely keep interest rates high for some time, he added. (…)

One of Wall Streets biggest optimists through much of last year’s market selloff, most of Kolanovic’s 2022 calls didn’t work out. He has since reversed his view, cutting his equity allocation in mid-December due to a soft economic outlook for this year. Last month, he said the economy was headed for a downturn. The bank reduced its recommended equity allocation once again due to fears of a recession and central-bank overtightening. (…)