One Eye on a chart: Could the Fed change its policy as early as 2023? We have some doubt.
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Written on September 27 2022 by Seeyond.
Let’s look at the facts:
- The job-hard-to-get component of US consumer confidence calculated by the Conference Board is negatively correlated with nonfarm payrolls and has traditionally been an excellent leading indicator of the health of the US labor market. Today, this component is at historic lows, indicating an extremely tight and robust labor market.
- Historically, the effect of a Fed funds rate hike on the labor market is not instantaneous. The chart below shows a lag of 20 to 36 months between the start of the rate hike and the start of the labor market deterioration.
- If we refer to the 70s and 80s, which seem to have the most similarities with the current period in terms of both inflationary pressures and monetary aggressiveness, we can reasonably assume that the current hiking cycle will start to have a significant impact on the labor market around Q1 2024 at best.
What do we think?
- The Fed is tightening its monetary policy. It communicates on “dots” but is data dependent, adjusting the strength of its bias according to the persistence of inflationary pressures. It closely monitors the evolution of the labor market and wages growth.
- In 2007/2008, the Fed's key drivers were the housing market and interbank rates due to the sub-prime crisis. In 2022, the Fed's main drivers seem to be job creations, unemployment rate and salary increases due to the impact on prices of the energy crisis, the post-Covid ultra-accommodative policy-mix and the demand recovery.
- The analysis of the various inflation measures, in particular the indicators calculated by the Atlanta and Cleveland Fed -excluding the most volatile elements- shows that rising prices are spreading to all sectors and that the price-wage loop is significantly underway.
- The bond market is still expecting Fed funds rate to fall in 2023. We see in these expectations a bit of complacency because: 1- when wage inflation is high and widespread, monetary policy seems to act with a minimum lag of 24 months and must be very aggressive to have a significant impact, 2- while the Fed wants to fight inflation "by all means", it should not take the risk of quickly sending too dovish messages likely to reverse financial conditions that have barely become neutral, 3- with a neutral rate that could be estimated at between 4 and 5% according to the Golden Rule, both current and anticipated key rates for 2023 are not yet in restrictive territory.
- In times of high inflation, the US labor market is slow to respond to rate hikes, requiring a long and painful restrictive monetary bias. The Fed could adopt a wait and see attitude before considering any changes.
Source: Bloomberg, Seeyond – Data from January 1971 to September 2022 – Monthly
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