Powell Says Fed’s Inflation Fight Could Take Years After raising rates rapidly over the past year, officials aren’t sure how much higher and faster to lift them
(…) Powell said because the Fed had lifted rates so quickly last year, there hasn’t been enough time to see the effects of those moves in slowing economic activity and inflation.
“Policy hasn’t been restrictive for very long…so we believe there’s more restriction coming,” Powell said during a panel discussion with other central bankers at the European Central Bank’s annual symposium in Sintra, Portugal. (…)
Powell said he doesn’t anticipate core inflation will return to the central bank’s 2% target until 2025. (…)
“The passage of time is not our friend here,” he said.
Most officials at the meeting penciled in two more increases this year. “The reason for that was if you look at the data over the last quarter, what you see is stronger than expected growth, tighter than expected labor markets, and higher than expected inflation,” said Powell. (…)
Powell said the failure of three midsize banks this spring had played a part in his desire to space out the Fed’s rate moves. (…)
The ECB this month lifted rates by a quarter percentage point, and its president, Christine Lagarde said officials would very likely increase interest rates again next month. She left open the possibility of a further rate increase in September.
Lagarde said she had been surprised by the resilience of Europe’s economy following enormous disruptions to energy markets and trade from Russia’s invasion of Ukraine. “Everybody thought the German model was dead, everyone would be on their knees. Resilience has been demonstrated at every level of society,” Lagarde said. (…)
“We were predicting a long but shallow recession, but the economy has been resilient,” said Bank of England Gov. Andrew Bailey. That resilience has been accompanied by a very tight labor market and large pay gains, Bailey said. (…)
Meantime, Bank of Japan Gov. Kazuo Ueda said he sees signs the country’s inflation rate is heading toward its 2% target, but isn’t yet confident enough to unwind its monetary easing.
Ueda said the central bank could change course if it becomes more convinced that inflation will be sustainably higher heading into 2024. Japan’s inflation rate has hovered at about 3% or higher since last summer. Core inflation was 3.2% in May.
Ueda pointed to recent increases in wages to suggest the country’s underlying inflation rate is still below 2%.
Bloomberg:
Powell and his Fed colleagues will get another reading on inflation on Friday, with the release of May data on the personal consumption expenditures price index.
Headline inflation on that measure is projected by economists to slow to 3.8% from 4.4% in April, in large part due to a decline in gasoline prices. But core inflation – which strips out food and energy costs and which policymakers view as more indicative of the underlying trend — is seen coming in unchanged at 4.7%, according to the median forecasts of economists surveyed by Bloomberg.
The Cleveland Fed’s Inflation Nowcasting sees Core PCE inflation at +0.38% in June, unchanged from May and unchanged from one week ago. That would be an annualized rate of 4.6% and +4.4% YoY.
This chart shows how little progress in core inflation there has been since March:
BTW, Bloomberg also reports that “We see the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy, particularly housing and investment,” Powell said in his prepared comments.
But when is the last time we saw new home sales jump 40% after a doubling in mortgage rates? Construction spending is up 15% in the last 15 months, capex are up 4.2%, neither series showing any signs or rolling over.
Ed Yardeni proved right with his rolling recession theme, for a while. He now sees a need to shift to a rolling expansion theme, with rates still rising globally!
Maybe the bite has yet to hurt. Listen to the Oaktree podcast below.
BCWYWF dept. (Be Careful What You Wish For)
The St. Louis Fed paper linked below tells us that all these Fed QEs post GFC set the stage for the excess retirements during AND after Covid, now partly responsible for the labor shortage and rising wages. But no worries, the San Fran Fed recently analysed “that labor-cost growth has a small effect on nonhousing services (NHS) inflation, as well as inflation overall. The estimates imply that the recent surge in the employment cost index explains only about 0.1 percentage point (pp) of current elevated inflation readings, a negligible portion of the 3pp increase in the core PCE measure.”
In effect, St. Louis says that the Fed is guilty but San Francisco says there is actually no real damage.
So Mr. Powell’s focus on NHS inflation, the so-called “super-core”, is actually inconsequential.
The San Fran Fed analysis also concludes that “labor cost growth does not appear to fuel inflation through higher demand.” Actually, “recent evidence shows that wage growth tends to follow inflation.”
But that contradicts a March 2023 paper by the grand-daddy, the Board of Governors of the Federal Reserve System, titled The Role of Wages in Trend Inflation: Back to the 1980s?
The results show that wages consistently inform estimates of underlying inflation. The weight on wages was highest around 1980, drifted down through the 2000s, and returned to its 1980s value by 2022. In addition, inflation in the 2020s appears to have unmoored moderately from the 2 percent range that prevailed for decades, as the role of the persistent component of inflation increased in recent year. However, accounting for wages lowers the model’s view of the increase in the volatility of trend inflation. (…)
In other words, forecasting inflation is difficult, irrespective of the information set used to construct forecasts. Nonetheless, the data support a signal role for wages, and this signal is more important at certain points, including the late 1970s and early 1980s and the 2020s (to date). While a substantial weight on wages in an estimate of trend inflation from this type of model indicates that wages are important for signal extraction, it does not indicate causality and points to the need for further empirical and theoretical work.
All clear then. 
Whatever. What is interesting in the below analysis is that there is evidence that the Covid excess retirements were not temporary.
Excess Retirements Continue despite Ebbing COVID-19 Pandemic
A 2021 Economic Synopses essay by Miguel Faria e Castro covered the COVID-19 retirement boom, using trend analysis to compare actual retirees with the natural trend that results from the aging of the baby boomer generation (those born between 1946 to 1965). This simple model estimated that there were just over 2.4 million excess retirees as of August 2021.
In a forthcoming Review article,1 we study the LFPR drop in greater detail, discussing how abnormal returns across financial asset classes may have contributed to excess retirements over the period of 2020-2022, and how much of the drop in LFPR can be attributed to these excess retirements. Further, we update the simple model of retirement in Faria e Castro’s 2021 essay, using the methodology from Joshua Montes, Christopher Smith and Juliana Dajon’s 2022 working paper (PDF).
In this post, we updated the results from our retirement model used in the Review article with the latest available data—April 2023—and investigated how the share of people retiring has compared with what we would expect under normal conditions in the final months of the COVID-19 emergency period, which ended in May 2023.
This updated model of retirement assumes that for a specific demographic group—defined as a combination of age, ethnicity, education and sex—the decision to retire depends on labor market conditions, the generosity of Social Security retirement benefits for that specific age group, and time trends that capture other secular changes to how different demographic groups approach labor market decisions.
We used these three factors to predict retirement shares for different demographic groups. We first divided the U.S. population into 780 demographic groups, with each subgroup being a combination of age (16 to 80 and older), sex (men and women), education (less than a bachelor’s degree, and a bachelor’s degree or more), and ethnicity (non-Hispanic white, non-Hispanic nonwhite, and Hispanic). For each of these 780 groups, we used a time trend, the unemployment gap, and the expected returns from Social Security to predict the expected share of retired people using historical, pre-COVID-19 data from 1995 to 2019.
The unemployment gap is simply the difference between the current unemployment rate and the natural rate of employment, as estimated by the Congressional Budget Office (CBO). We included this variable as there is a large body of research that finds that current labor market conditions affect people’s decision to participate in the labor force.
To calculate expected returns from Social Security, we calculated how much an individual would be penalized or rewarded for retiring at their current age. The Social Security Administration (SSA) provides information on your normal (full) retirement age—which is dependent on what year you were born—and the penalty or reward for retirement—which is based on how many months you are from the normal retirement age.2 We only calculated this variable for people in our sample who are ages 62 to 70, because 62 is the minimum age to begin receiving reduced benefits, and after 70 you can no longer accrue additional benefits from delaying retirement.
In the figure below, we compare the actual share of people who are retired, as a percentage of the civilian noninstitutional population age 16 and older, to our predicted share of retirements based on the model described above.
Actual Retirements Began to Greatly Surpass the Predicted Trend during the Pandemic
As shown in the figure, the actual share of retirements roughly tracked the predicted share from January 2000 through February 2020, when the actual share was 18.1%. In the first three months of the pandemic, however, actual share quickly increased to 18.6% versus a predicted share of 18.2%, implying just over one million excess retirees in May 2020.
The gap between actual and predicted shares of retirements continued to grow throughout the COVID-19 pandemic and peaked in December 2022, implying an estimated 2.95 million excess retirees in that month.
Starting in 2023, the model line begins to flatten out—meaning that predicted retirements are leveling off after consistently increasing from approximately 16% in 2012 to just over 18.6% in the first four months of 2023. In 2023, the actual share has also decreased since the peak of 19.8% in December 2022.
As of April 2023, we estimate that there were approximately 2.4 million excess retirees in the U.S. Excess retirements are still well above our predicted trend, which may be contributing to a continued tightness in the labor market and low unemployment rate since the recovery from the pandemic recession.
Micron Delivers Strong Forecast in Sign That Glut Is Easing
Sales will be as much as $4.1 billion in the fiscal fourth quarter, the company said in a statement Wednesday. That compares with an average analyst estimate of $3.87 billion.
“We believe that the memory industry has passed its trough in revenue, and we expect margins to improve as industry supply-demand balance is gradually restored,” Chief Executive Officer Sanjay Mehrotra said in the statement. But recent actions in China — where the government has decided that Micron’s products are a security risk — “is a significant headwind that is impacting our outlook and slowing our recovery,” he said.
Like many of its peers, Micron has suffered a collapse in orders for its products after sluggish demand for smartphones and personal computers led to a buildup of inventory. The company’s projection indicates that customers have worked through those stockpiles and are now returning to purchasing again. (…)
Though Micron’s customers are emerging from a pile of excess inventory, the company isn’t predicting a rapid return to growth in 2023. PC shipments are expected to decline by a “low double-digit” percentage from a year ago, slumping to a level that’s below where that market was before the pandemic. The smartphone industry will contract by a percentage in the mid-single digits from a year ago, Micron predicted. (…)
Worth listening to:
Conversations – This Time Might Be Different with Howard Marks and David Rosenberg
Howard Marks (Co-Chairman) and David Rosenberg (Co-Portfolio Manager, U.S. High Yield, Global High Yield, Global Credit) discuss topics from the June 2023 edition of The Roundup. They consider the evolution of the high yield bond market, investor optimism, and why this time might actually be different in financial markets.
This chart will help you visualize what David calls the coming reckoning. Floating rate debt now costs 550bps more than in 2021. Fixed rate debt is being renewed at double its pre-2022 cost. The hit on cashflow will only keep growing through 2025.
Since U.S. nonfinancial corporate debt reached $12.7T as of Q1’23, a 550bps incremental cost would reduce annualized cashflow by $636B or $500B after tax, a 16% setback on total corporate cashflow and 20% on corporate profits.
This topdowncharts.com chart shows that this is global and is concurrent with tightening standards across the world. Things are likely to get worse before they get better.
