Fed Slows Its Tightening With Quarter-Point Rate Rise The central bank acknowledged reduced inflation but signaled plans to increase short-term interest rates again in March.
(…) “We’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive,” Fed Chair Jerome Powell said at a news conference after the central bank’s policy meeting. (…)
In December, most Fed officials penciled in raising the fed-funds rate to a range between 5% and 5.25% this year, with none projecting cuts. After the hike that they approved Wednesday, that projection would imply additional quarter-point increases at the Fed’s meetings in March and May, followed by a pause in rate rises. (…)
Mr. Powell repeated his earlier view that a tight labor market would keep upward pressure on wages and prices even though they have moderated recently. He also cited reasons the economy might prove resilient, including from an increase in public spending on construction projects and an increase in inflation-adjusted wages as price increases slow this year. (…)
Mr. Powell suggested that he continued to see the risk of not raising rates enough and allowing inflation to reaccelerate to be more dangerous than raising rates too high and causing a recession. In the latter alternative, the Fed could react immediately by cutting rates, he said.
The first mistake would be harder to fix because it would risk a period of more entrenched inflation that would ultimately require a deeper recession to break consumers’ and business expectations of higher prices, he said. “I continue to think that it’s very difficult to manage the risk of doing too little and finding out in six or 12 months that we actually were close but didn’t get the job done and inflation springs back,” Mr. Powell said.
- Beneath the Surface, Fed Sees No Letup in Inflation Pressure While acknowledging much of recent inflation proved transitory, Fed sees no reason to pause rate increases in wage, labor data
(…) “We can now say for the first time the disinflationary process has started,” he said. In fact, he argued the Fed’s initial view that much of the rise in inflation would be transitory has been borne out, though it took more than a year longer than expected.
So why no victory lap? Because as Mr. Powell emphasized, even if most of the rise in inflation was transitory, some of it wasn’t. Falling goods prices led the recent moderation in core inflation, the predicted result of supply chains becoming unsnarled and consumer demand rotating back to services. But just as the initial spike in goods prices was transitory, so will this recent decline, Mr. Powell noted.
Once those factors wash out, Mr. Powell said “sustainable” inflation would be more like 4%—a discouragingly high number. (…)
Mr. Powell’s preferred measure of underlying inflation is services excluding food, energy and shelter, and he said about 60% of that responds to slack in the economy, according to Fed research—in other words, how tight the labor market is.
To be sure, as Mr. Powell acknowledged, Tuesday’s report on fourth-quarter employment costs showed private-sector wage growth moderating notably during 2022. But he said it is too high to be consistent with 2% inflation. Harvard University economist Jason Furman estimates recent wage data was consistent with inflation falling to a 3.5% to 4% pace. (…)
Inflation, Mr. Powell said, won’t return to 2% “without a better balance in the labor market.” (…)
Fed policy used to focus on Core-PCE, shunning the CPI because of its particular construction (weights). Now, Mr. Powell tells us that the key inflation variable guiding Fed policy is CPI-Services ex-Shelter because this is the segment, 25% of CPI, that best reflects wage trends.
Here’s the chart for your appreciation: blue is the targeted inflation villain that wages (red) are seen waggling. The period is 1984 to 2019 to exclude the pandemic distortions.
CPI-Services ex-Shelter vs Wages
In this chart, I swapped wages with energy costs (note the two vertical axis to reflect very different amplitudes).
CPI-Services ex-Shelter vs Energy Costs
Lastly, here’s the Shelter vs Wages chart:
CPI-Shelter vs Wages
FYI, this next chart shows the QoQ change in the “targeted inflation villain”. If we follow Mr. Powell’s causality analysis, the FOMC jacked up rates 4.5% because CPI-Services ex-Shelter went out of range during 4 pandemic quarters:
CPI-Services ex-Shelter (QoQ)
The blue bars below are MoM changes in wages at service providers:
What needs to be done is forecast energy costs. Good luck!
(…) Arguably, his critical mistake came early in the Q&A, when he was asked if he was worried that financial conditions had eased. This appeared to be a straightforward opportunity for him to say “yes” and browbeat the market. He didn’t. Instead, remarkably, he said that financial conditions had tightened. They haven’t. (…)
It was at this point that traders started piling into both stocks and bonds. Neil Dutta, head of economics at Renaissance Macro Research, said that Powell’s mischaracterization of financial conditions “was dovish in its own right” and that the odds were increasing the Fed’s “flirtation with the soft landing today increases the risk of a harder landing later.” (…)
Where data-dependency takes you depends on which data you choose to depend on. Three reasonably important data points from Wednesday morning would lead you to three different paths for the Fed. To start with, the JOLTS survey showed job vacancies rising again, very much counter to expectations. There are now roughly two vacancies in the US for every officially unemployed person. That implies overheating, no reason for the Fed to fear that it will provoke a recession, and every reason to keep hiking.
But then we come to the survey of private sector employment by the ADP payroll processing group, which every month attempts to preempt the official non-farm payroll numbers. This suggests that the labor market is at last calming down, with the smallest increase to payrolls in almost two years, while doing nothing to raise any great fears. This would imply the Fed is nicely on target for a soft landing, and can probably start to let rates come down by about the end of the year:
But then we come to the ISM supply managers’ survey of manufacturing, which has proved to be a great leading indicator for the economy over the years. Most eye-catching was a continuing drop in new orders, implying demand is dropping sharply. As this chart shows, they have never fallen this low without soon ushering in a recession. On the face of it, this implies an imminent hard landing and a pressing need for the Fed to pivot, and pivot soon:
Even data-dependency doesn’t help much at present, then. With an economy so difficult to read, it might be better to devote efforts to working out exactly what scenario is unfolding. The Fed seems more uncertain than a very significant bloc of traders who have been moving prices in the last couple of months. In that uncertainty, I think the Fed is right.
U.S. Job Openings Jumped at End of Last Year Demand for workers has been elevated since mid-2021. Layoff totals increased slightly in December as some companies announced job cuts.
A seasonally adjusted 11 million jobs were available in December compared with a downwardly revised 10.4 million the prior month, the Labor Department said Wednesday.
Job openings are down from a peak of 11.9 million last March, but they are still historically high and exceed December’s 5.7 million unemployed workers looking for work by a ratio of nearly two to one. Jobs site Indeed estimated there were 10.1 million job openings in mid-January.
Layoffs increased to a seasonally adjusted 1.5 million in December from 1.4 million the prior month, the Labor Department said. Though still below prepandemic levels, December layoffs were more than 15% higher than in the same month a year earlier, when there were 1.3 million layoffs. December layoffs were driven by job cuts in infrastructure, business services and hospitality industries. (…)
The December increase in job openings was driven by food services, retail trade, and construction, while the biggest decline was seen in the information industry.
Which line do you trust? Openings or actual hires:
Focusing on retail trade with all 3 series indexed to 100 = pre-pandemic levels. How can openings jump when demand is down? Hires are more realistic.
Same with construction:
Recall that Job Openings are top of Mr. Powell’s list assessing the labor market, still qualified as “very, very strong” yesterday.
MANUFACTURING PMIs
USA: Further solid decline in manufacturing performance at start of the year
The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI™) posted 46.9 in January, up slightly from 46.2 in December and broadly in line with the earlier released ‘flash’ estimate of 46.8. The latest data signalled a solid deterioration in operating conditions across the US manufacturing sector, and one that was the second-fastest since May 2020.
Demand conditions across the sector remained muted at the start of the year, as new orders fell at a steep rate. The decrease in new sales softened from that seen in December, but was nevertheless the second-sharpest in just over two-and-a-half years. Client hesitancy and order postponements following the impact of inflation and economic uncertainty on customer spending reportedly drove the downturn.
New export orders also declined further in January, down for an eight straight month, albeit with the pace of contraction easing.
Production levels at goods producers also decreased at a solid pace. The rate of contraction was among the fastest since the global financial crisis, despite slowing slightly from December.
Reversing the downwards trend seen since last June, the rate of cost inflation ticked higher in January. Greater input prices were attributed to hikes in material and transportation costs. The pace of increase was slower than the series average, however, and was the second-softest since October 2020.
Similarly, output charges rose at a quicker rate at the start of 2023. Efforts to pass higher costs through to customers pushed selling prices up, according to panellists. The pace of charge inflation was historically elevated despite being slower than seen throughout the last two years.
January data indicated only a fractional rise in workforce numbers at manufacturers. The rate of job creation eased for the fourth month running amid challenges hiring suitable staff and retaining skilled workers.
Meanwhile, suppliers’ delivery times were broadly stable in January amid some reports of easing logistics delays. Partially contributing to stable vendor performance was a drop in demand for inputs among manufacturers. Input buying fell at one of the steepest rates on record as firms sought to run down stocks following weak demand and cost reduction efforts. Both pre- and post-production inventories contracted at the start of the year, often reflecting deliberate cost-driven inventory reduction policies.
Finally, US manufacturers were strongly confident of an uptick in output over the coming 12 months in January. The degree of optimism picked up to an eight-month high amid hopes of a soft landing for the economy, further supply chain stability, greater demand and additional investment in new products and marketing.
The ISM:
“The January Manufacturing PMI® registered 47.4 percent, 1 percentage point lower than the seasonally adjusted 48.4 percent recorded in December. Regarding the overall economy, this figure indicates a second month of contraction after a 30-month period of expansion. (…)
The New Orders Index remained in contraction territory at 42.5 percent, 2.6 percentage points lower than the seasonally adjusted figure of 45.1 percent recorded in December. (…)
New order rates remain depressed due to buyer and supplier disagreements regarding price levels and delivery lead times (…). Panelists’ companies are attempting to maintain head-count levels during the anticipated slow first half in preparation for a strong performance in the second half of 2023.
Demand eased, with the (1) New Orders Index contracting strongly, (2) New Export Orders Index still below 50 percent but improving, (3) Customers’ Inventories Index contracting slightly, a positive for future production and (4) Backlog of Orders Index recovering for a second month, but still in strong contraction. (…)
The ISM adds that only 2 industries reported growth in January vs 15 reporting contraction. None of the 18 manufacturing industries reported growth in new orders in January. Seventeen industries reported a decline in new orders in January.
WHAT RESPONDENTS ARE SAYING
- “Business is still strong, but we have begun to see softening in some pricing, and lead times seem to be improving.” [Computer & Electronic Products]
- “Conditions are reasonable. Sales are a little better than planned. Cost pressures are easing for most products. There have been a lot fewer supply disruptions so far this year, and few expected in the short term. The crystal ball remains a little blurry for the rest of 2023.” [Chemical Products]
- “Sales have dropped (as expected) at the beginning of the year. Forecast from the sales department is showing even lower sales then we expected. If this holds true, inventory levels will rise slightly over next month and a half.” [Food, Beverage & Tobacco Products]
- “Supply chain issues continue to plague our production schedules. Transportation from our overseas suppliers is also contributing to delays. Lead times have doubled for critical electronics, gaskets, sealants, and specialized steel.” [Transportation Equipment]
- “Strong big ag demand continues to drive heightened demand for parts. Large construction/off highway original equipment manufacturers have strong demand as well. Creating continued capacity constraints with the supply base.” [Machinery]
- “Some business segments showing demand softening globally. Many materials showing improved lead times as well as cost deflation.” [Electrical Equipment, Appliances & Components]
- “Thus far, the outlook for the first half of 2023 looks very soft. Demand for our products has taken a sharp downward turn. Our inventories are high, as well as our customers’. It seems everyone is bracing for a recession.” [Fabricated Metal Products]
- “Customers are being quite aggressive in pursuing price decreases, far beyond the price relief we are actually receiving from our suppliers.” [Miscellaneous Manufacturing]
- “Industrial construction is strong. Commercial construction is slower.” [Nonmetallic Mineral Products]
- “In the past two weeks, we are seeing a slowing of new orders.” [Primary Metals]
Canada: Return to modest growth of Canadian manufacturing economy
The seasonally adjusted S&P Global Canada Manufacturing Purchasing Managers’ Index® (PMI®) recorded 51.0 in January, up from 49.2 at the end of 2022. Latest data marked the first time that the index has recorded above the 50.0 no-change mark that separates growth from contraction since last July.
There were concurrent increases in both manufacturing output and new orders during January. Companies reported that market demand was improving, and that the marginal increase in sales seen at the start of the year had encouraged firms to raise their output. However, any growth primarily emanated from the domestic market as new export orders fell for an eighth month in a row. Underlying global demand was reported to have remained soft, according to panellists.
Firms remained suitably encouraged to hire additional workers. Employment growth was modest, but nonetheless the best recorded by the survey since last July. There was evidence that jobs were added to bolster productive capabilities. Positive projections for growth in the months ahead were also noted as confidence about the future remains in positive territory.
Firms are hoping that market demand and input supply will continue to stabilise over the months ahead. Although average lead times for the delivery of inputs lengthened again in January, amid residual supply challenges in shipping freight services and border delays, several firms commented that vendors were finally getting on top of the backlog difficulties that have been so prominent since the start of the pandemic.
Nonetheless, expectations for output in the year ahead did slip a little in January, falling to a three-month low as firms worry about the possibility of recession in the months ahead. This helped explain why manufacturers continue to take a cautious approach to purchasing activity, which fell for a sixth successive month (albeit to the lowest degree in the current sequence). Firms noted a preference to lean on existing inventories wherever possible, and this meant that stocks of inputs fell again at the start of 2023.
Lower purchasing activity also helped to relieve supply pressure on vendors and ensured that input price inflation resumed the steady downward trend seen throughout much of 2022. Overall, input prices rose markedly – reflective of some persistent, and somewhat systematic, price inflation – but at their lowest pace for nearly two-and-a-half years. Output charges also increased at one of the slowest rates in the past two years during January.
BUSINESS EMPLOYMENT DYNAMICS
Last December, I wrote about a Philly Fed report that refutes the notion of a “very, very strong job market”, rather showing that there was actually no growth in U.S. employment in 2022:
Estimates by the Federal Reserve Bank of Philadelphia indicate that the employment changes from March through June 2022 were significantly different in 33 states and the District of Columbia compared with current state estimates from the Bureau of Labor Statistics’ (BLS) Current Employment Statistics (CES). (…)
In the aggregate, 10,500 net new jobs were added during the period rather than the 1,121,500 jobs estimated by the sum of the states; the U.S. CES estimated net growth of 1,047,000 jobs for the period.
So, the Philly Fed was saying that the BLS’ job numbers for Q2’22 were overstated by about 1 million jobs annualized, or about 0.6%.
I added:
Interestingly, based on various data I was observing last June, I wrote that the economy appeared to have hit a wall in March. Last December 12, I observed that, since March, “household employment has been unusually weaker than establishment employment”. In fact, YtD, household employment is up 1.6% while payroll employment is up 2.9%, a difference of 1.8 million jobs.
The two employment series have a correlation of 98.7% since 1950. Between 1990 and 2019, household based employment has grown 2.1% per year, slightly faster than establishment based jobs’ 1.9%. Since the pandemic, payroll employment has outpaced household employment, 1.66% per year vs 1.24%.
Either the unemployment rate is understated or payroll employment is overstated. The Philly Fed work strongly suggests the latter.
While I was away last week, the BLS released its Business Employment Dynamics report which tallies up gross job gains and losses in the private sector:
The change in the number of jobs over time is the net result of increases and decreases in employment that occur at all private businesses in the economy. Business Employment Dynamics (BED) statistics track these changes in employment at private-sector establishments from the third month of one quarter to the third month of the next. The difference between the number of gross job gains and the number of gross job losses is the net change in employment.
Drum roll:
From March 2022 to June 2022, gross job gains from opening and expanding private-sector establishments were 8.3 million, a decrease of 185,000 jobs from the previous quarter. Over this period, gross job losses from closing and contracting private-sector establishments were 8.5 million, an increase of 1.6 million jobs from the previous quarter.
The difference between the number of gross job gains and the number of gross job losses yielded a net employment loss of 287,000 jobs in the private sector during the second quarter of 2022.
The BLS Establishment Survey said that 1.2M jobs were created in Q2’22 (blue bars below).
The Philly Fed analysis said that number was actually 0.2M.
Now the BLS says that net private employment rose 0.3M.
Coincidentally, the BLS other survey, the Household Survey had net job gains at 0.4M in Q2’22 (red bars).
Since March 2022, Household employment averaged 33% of Establishment employment. It was down to +61k per month on average in Q4
OPEC+ Ministers Stick to Cutting Plan Amid Oil-Demand Uncertainty
A panel of OPEC+ energy ministers Wednesday said the group of petrostates would continue cutting oil production, amid uncertainties about demand in China and the impact of sanctions on Russian crude supplies.
Maintaining the status quo will allow the Organization of the Petroleum Exporting Countries and a group of producers led by Russia—collectively known as OPEC+—to take more time to assess consumption data from China, the world’s biggest oil importer, and determine how a resurgence of Covid-19 cases there and European Union sanctions on Moscow have affected demand.
Delegates said that OPEC+ wants to remain conservative in their approach until there are clearer signals that markets require higher crude supplies.
OPEC+ decided in December to lock in a 2 million-barrel-a-day production cut that had been decided in October. The decision suggests that the world’s leading oil producers are uncertain about the direction of crude prices, ahead of a price cap on Russian petroleum exports set to take effect. (…)
EARNINGS WATCH
Caterpillar CEO “doesn’t see signs of improvement at this point” in Chinese demand. Specifically, it was noted that the company’s benchmark for Chinese demand — the 10-ton-and-above excavator market — will be weaker this year than last.
FYI:
And from INK Research:
The situation at the stock level is in stark contrast to the broad market where insider sentiment remains ho-hum. For the last three months, our INK US Indicator has been stuck in a range from 38% to 44%. At 40% there are four stocks with key insider buying for every 10 stocks with key insider selling. However, absolute dollar insider selling levels have been at average levels. This has left the broad US market stuck in the fair-valued zone based on insider signals.
