Even if Fed Stays on Hold, Jerome Powell Is Keeping His Options Open The Fed chair said it was premature for the central bank to declare a conclusive end to its historic interest-rate increases of the past two years even though he didn’t make an argument for further hikes right now.
Price and wage pressures have eased recently, leading more investors to think the Fed is done raising rates. Powell disappointed those investors in a speech Thursday by explaining why he thinks the Fed is more likely to tighten policy than ease it if any change is warranted.
While Powell didn’t build a case for lifting rates now, he pointed to earlier inflation “head fakes,” past episodes in which price pressures ebbed for a while before surprising Fed officials by picking up again. He said they would monitor economic conditions closely to avoid both the risk of having been “misled by a few good months of data,” as well as the risk of having raised rates too high, Powell said. (…)
In his prepared remarks for a conference at the International Monetary Fund, Powell said the central bank was “not confident” that it had raised rates high enough to lower inflation to its 2% goal in the next two or three years.
But during a question-and-answer session, Powell allowed that inflation-adjusted interest rates were high. “We’re in the place where we have restrictive policy, and probably significantly restrictive policy, and we’re watching the effect carefully on the economy,” he said. (…)
The Fed chair cautioned that continuing to bring down inflation could be harder if those supply-side tailwinds had run their course. “We know that ongoing progress toward our 2% goal is not assured,” he said.
Bank of Canada Governing Council deliberations
This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on October 25, 2023.
Substitute Canada with USA and Governing Council with FOMC and you would probably get the verbatim of the last FOMC meeting. What about data dependency?
Canada’s economic growth had slowed over the past year, averaging about 1%. Members agreed signs were clearer that monetary policy was working to dampen spending. With demand slowing and supply catching up, the economy was approaching balance.
Consumer spending was weaker than expected. Members noted that household credit growth had declined substantially as households adjusted to higher borrowing costs. Responses to the Canadian Survey of Consumer Expectations for the third quarter pointed to more weakness in spending on housing and durable goods, and members noted that weaker spending had begun to spread to services.
Exports were expected to stall as foreign demand softened. And businesses responding to the Business Outlook Survey for the third quarter reported softer investment intentions due to elevated funding costs and weaker sales prospects.
Governing Council members discussed the aggregate spending plans of federal and provincial governments, which are projected to increase at an annual pace of roughly 2.5% in 2024. If all those plans are realized, this would contribute materially to growth over the next year. By adding to demand at a faster pace than the growth of supply, government spending could get in the way of returning inflation to target.
On the labour market, Governing Council agreed that a wide range of indicators pointed to continued easing. But overall, the labour market still looked to be on the tight side:
- The pace of job creation had slowed to below that of labour force growth.
- Businesses reported widespread easing in the intensity of labour shortages.
- Job vacancies had declined gradually but were still above pre-pandemic levels.
- The unemployment rate had risen slightly but was low by historical standards.
- Wages continued to grow in a range of between 4% and 5%.
Members observed that the pace of recent wage growth partially reflected a catch-up in real wages. Some businesses reported plans to continue raising salaries to retain workers. Members discussed the likelihood that chronic labour shortages could persist in sectors such as health care and skilled trades, even as the overall tightness in the labour market continued to recede.
Governing Council reviewed recent data on inflation. While consumer price index inflation had declined from a peak of 8.1% since June 2022, recent inflation data had been volatile: 2.8% in June 2023, 4% in August and 3.8% in September. Nevertheless, members agreed that the effects of higher interest rates were increasingly reflected in the prices of many goods that people buy on credit, such as furniture and appliances.
Progress in reducing inflation is also evident in the prices of many semi-durable goods and services excluding shelter. Along with durable goods, these components grew at 2% or less in September. Inflation in services excluding shelter was below its historical contribution to inflation overall, but there had been some unusual volatility in certain services prices. Food price inflation eased as well but remained elevated at close to 6%. Members agreed that food price inflation should moderate further as lower input costs are passed along to final food prices.
Despite this progress, members revised up their near-term outlook for inflation. Members discussed several factors that had been standing in the way of the disinflationary process:
- Higher global oil prices had pushed up gasoline prices. This was the main factor behind the rebound in inflation since June.
- Shelter price inflation was running around 6%. This was partly due to rising mortgage interest costs following increases in the policy interest rate. But high shelter price inflation was also evident in rent and other housing-related costs. Higher interest rates would normally exert downward pressure on house prices and other costs that are closely linked to house prices, such as maintenance, taxes and insurance. However, the ongoing structural shortage of housing supply in the economy was sustaining elevated house prices. And the rapid increase in Canada’s population had added to the existing imbalance between demand and supply for housing.
- Near-term inflation expectations and wage growth remained elevated.
- Corporate pricing behaviour was normalizing only gradually.
Together, these factors were contributing to persistence in inflation. Measured on a three-month annualized basis, core inflation had been stuck in a range of 3.5% to 4% for the past year, suggesting little downward momentum in underlying inflation.
As a result, Governing Council members revised up their forecast for inflation in the near term. But with a weaker growth outlook and more excess supply, they continued to expect inflation would return to the 2% target in 2025. (…)
At the October meetings, members agreed that the evidence demonstrated further progress toward rebalancing the economy. Monetary policy continued to gain traction—excess demand was being absorbed, and price pressures were easing for many goods and services.
However, members acknowledged that the translation of weaker demand into lower price growth had been slow. The lack of downward momentum in underlying inflation was a source of considerable concern. They reflected again on the two possible explanations for this persistence: that the transmission of monetary policy actions through to inflation required more time, or that monetary policy was not yet restrictive enough to relieve price pressures.
Members discussed whether the stickiness in core inflation measures reflected the fact that excess demand remained in the system or that inflation could be becoming entrenched.
While the output gap indicated the economy was entering a period of excess supply, considerable uncertainty surrounds this estimate. Latent excess demand could explain why:
- the labour market remained on the tight side
- businesses continued to raise prices more often than normal
- near-term inflation expectations remained elevated
Wage growth, if sustained at the current pace of 4% to 5%, would be inconsistent with restoring price stability. Members agreed they would be watching closely to see if higher labour costs began to be reflected in renewed inflationary pressures.
On corporate pricing behaviour, despite some progress toward normalization, many businesses were still reporting that they would raise prices more frequently than normal. Members expressed concern that businesses would:
- be slower to pass on price decreases as input costs decline
- increase their prices more rapidly in response to future shocks
Finally, members noted that while near-term inflation expectations remained elevated, they had been easing. Long-term inflation expectations remained well anchored. Thus, current household spending and business decisions more likely reflected recent experiences with inflation rather than an acceptance that high inflation was here to stay.
As excess demand continues to be absorbed, persistence in core inflation, elevated inflation expectations and wage growth, and atypical corporate pricing behaviour could be indications of high inflation becoming entrenched. In such a scenario, members acknowledged that further monetary policy tightening would likely be required to restore price stability.
Members also discussed the implications of elevated shelter price inflation for monetary policy. Given that increasing the supply of housing enough to substantially narrow the shortfall will take time, shelter price inflation could continue to contribute more than normal to overall inflation for some time.
Finally, Governing Council also discussed the risk that the economy could slow more than expected. The outlook for GDP had been revised down from the July MPR, in part due to tighter financial conditions globally. If global financial conditions tighten further or past increases in the policy interest rate restrain demand more than expected, the economy could be weaker and inflation lower than projected.
Overall, Governing Council members agreed that monetary policy was working to lower demand and ease price pressures for many goods and services. They also agreed that as the economy moved into excess supply, past monetary policy tightening should continue to translate into lower inflation. However, with a higher near-term forecast for inflation and persistent core inflation, as well as the risk that rising global tensions could lead to higher oil prices or renewed supply chain disruptions, they agreed that overall inflationary risks had increased.
Governing Council discussed whether monetary policy was sufficiently restrictive to return inflation to target.
Some members felt that it was more likely than not that the policy rate would need to increase further to return inflation to target. Others viewed the most likely scenario as one where a 5% policy rate would be sufficient to get inflation back to the 2% target, provided it was maintained at that level for long enough.
However, there was a strong consensus that, with clearer evidence of higher interest rates moderating spending, slowing growth and relieving price pressures, Governing Council should be patient and hold the policy rate at 5%. They agreed to revisit the need for a higher policy rate at future decisions with the benefit of more information.
Given the slower-than-expected progress toward price stability and increased inflationary risks, members agreed to state clearly that they were prepared to raise the policy rate further if needed.
Members noted that they needed to see downward momentum in core inflation to be confident that monetary policy was sufficiently restrictive to restore price stability. They agreed to continue to assess the evolution of underlying inflationary pressures by focusing on the following indicators:
- the balance between demand and supply in the economy
- inflation expectations
- wage growth
- corporate pricing behaviour
Members also reviewed the Bank’s quantitative tightening program and agreed to continue the current policy of normalizing the balance sheet by allowing maturing bonds to roll off.
BTW:
- ECB Vice President Luis de Guindos says any talk of lowering borrowing costs in the coming months is too early, citing continued upside risks to inflation (@economics)
- RBA Warns Inflation More Persistent Than Expected The Reserve Bank of Australia sharply revised up its forecasts for core inflation in the near term and warned that inflation pressures are cooling at a slower pace than anticipated.
About wages:
The Atlanta Fed’s Wage Growth Tracker
The Atlanta Fed’s Wage Growth Tracker was 5.2 percent in October, the same as for September. For people who changed jobs, the Tracker in October was 5.6 percent, also the same as in September. For those not changing jobs, the Tracker was 4.8 percent, down from 5.0 percent in September.
More junk-rated companies downgraded than upgraded in October -JPM
October saw downgrades to 18 junk bond issuers’ ratings accounting for $22.2bn in debt, while just 16 issuers were given upgrades by ratings agencies, the JPMorgan report said.
This is the first time downgrades have surpassed upgrades on U.S. junk-rated borrowers in four months, it added. (…)
Ratings agency Moody’s Investors Service has forecast defaults among low-rated U.S. companies will peak at 5.6% in January 2024, before falling to 4.6% by August 2024.
October’s ratings actions reflect a broader trend as there have been 293 downgrades totaling $393 billion over the last 12 months, compared to 264 upgrades equaling $479 billion, the JPMorgan report said.
The largest number of junk issuer downgrades this year have been in the healthcare and financial sectors.
While high-grade companies’ credit ratings have proven resilient during the Federal Reserve’s interest-rate hikes, businesses with significant leverage and floating-rate debt have struggled to keep pace with rising debt-servicing costs.
China Is Making Too Much Stuff—and Other Countries Are Worried Factories lack customers and are pushing exports harder, raising trade tensions
Makers of electric vehicles, solar panels and other products are cutting prices and trying harder to muscle into overseas markets as they face weakened demand at home, upsetting competitors who see threats to their bottom lines.
The tensions are most acute in Europe, where European Union regulators in September unveiled an antisubsidy probe, reflecting concern that China is flooding the region with low-cost electric vehicles. (…)
Prices of goods shipped from China have fallen around 20% this year, according to ABN AMRO. While some of that drop reflects easing supply-chain bottlenecks, it is also a sign that Chinese sellers are discounting to preserve or expand market share during a period of weaker global demand, according to economists.
Local governments in China have been subsidizing trips abroad for companies to sell more overseas, including chartering flights for them. They are urging banks to lend to companies that want to expand in countries participating in China’s Belt and Road program.
Beijing has also called on financial institutions to direct credit to the manufacturing sector.
Chinese manufacturers are reaping an extra advantage from a declining currency, with the Chinese yuan at its weakest level against the U.S. dollar in more than 15 years, making their goods less expensive overseas.
In an August report, Goldman Sachs singled out several products that are oversupplied in China, including batteries, excavators and some chemicals.
(…)JPMorgan estimates that falling producer prices in China will lower global core goods inflation outside the country by 0.7 percentage point over the second half of 2023. (…)
With more than 100 car brands, many unprofitable, and slowing sales growth at home, China’s auto industry has a powerful incentive to look for more-lucrative markets overseas, according to a recent report by Rhodium Group, a research company.
China’s share of global EV exports grew from 4% in 2020 to 21% in 2022, it said.
While many of those exports are foreign brands that produce in China, especially Tesla, Chinese brands, with their lower sticker prices, are becoming a bigger part of the picture. Their share of total EU EV sales grew from 0.5% in 2019 to over 8% so far in 2023, according to Schmidt Automotive Research.
(…)China needs to find more markets for its conventional gasoline-powered autos, as domestic consumers shift toward EVs, said Andrew Batson, a China-focused analyst at Gavekal. China’s exports of gas cars have risen sixfold over the past three years, according to Batson. (…)
“Their incentive to keep that capacity active by pushing vehicles into export markets at low prices is only getting stronger,” he said. (…)
In Europe, solar module prices fell by 50% within four weeks starting late last year even though market fundamentals were largely unchanged during that period, said Gunter Erfurt, chief executive officer of Meyer Burger Technology, a Switzerland-based manufacturer of solar cells and modules.
To Erfurt, it was a sign China was discounting at what he called “unprecedented speed” to grab market share. (…)
European solar producers sent a letter to EU authorities in September urging them to buy up their inventories to avert a new wave of bankruptcies related to intensifying Chinese competition and slowing demand in Europe. (…)
China’s steel export prices have plunged about 60% from a year earlier, while its steel exports volume went up 53% in October compared with 2022, according to Frederic Neumann, chief Asia economist at HSBC. (…)
Some related charts from Ed Yardeni for your appreciation of that case:
