Tim Duy’s Fed Watch, 5/3/22

Published on May 3, 2022
SGH Insight
JOLTS, Final Thoughts Ahead of the FOMC Meeting
The JOLTS report is sure to reinforce Federal Reserve Chair Jerome Powell’s conviction that the labor market is overheating. Job openings unexpectedly rose to 11.5 million, slightly surpassing the previous high of 11.4 million:
Market Validation
FOMC Press Conference

>> CHAIRMAN JEROME POWELL: For now, we are focused on doing the job we need to do, on demand, there is plenty to be done there. If you look at it essentially, it's almost two to one job vacancies to unemployed people. There is a lot of excess demand, more than five million more employed plus job openings than there are the size of the labor force. There is a imbalance that we have to work on. It's difficult situation, you would look at core inflation, which wouldn't include the commodity price shocks, and that is one of the reasons we tend to focus on that, because we can have more of a effect on that. But it would be a very difficult situation. We have to be sure that inflation expectations remain anchored, and that is part of our job too. We will be watching that carefully. It puts any Central Bank in a very difficult situation.

JOLTS, Final Thoughts Ahead of the FOMC Meeting

The JOLTS report is sure to reinforce Federal Reserve Chair Jerome Powell’s conviction that the labor market is overheating. Job openings unexpectedly rose to 11.5 million, slightly surpassing the previous high of 11.4 million:

Quits rose as well:

In a worst-case scenario for the Fed, the elevated level of quits would be driven not by workers simply seeking better employment opportunities, but because workers were forced to seek higher wages to keep up with inflation. The Wall Street Journal recently raised this possibility:

…Today, workers are quitting at rates that well exceed those preceding the pandemic, receiving large wage increases.

That includes employees like 37-year-old Dain Laguna.

Mr. Laguna was working in a human-resources job at a home-improvement company last year, feeling undervalued at an hourly wage of $19. Rising inflation started eating into his already tight budget. For instance, prices for fresh organic food—which he prefers to feed to his kids—became a financial stretch.

This kind of dynamic would indicate a deepening inflationary psychology among the public which would eventually reveal itself in elevated inflation expectations.

The gap between openings and the level of unemployment continued to widen in March:

Powell has said the Fed hopes it can cool the labor market and reduce job openings without triggering a recession. You know my story – the gap between openings and unemployment is so wide at this point we need a substantial drop in openings to rebalance the labor markets, but such a drop typically does not happen absent a recession.

Finally, the evidence continues to support the case for a large, persistent shift in the Beveridge curve:

This would be consistent with a sharp rise in the natural rate of unemployment and not only explains why wage growth is surging but also suggests that wage growth will remain high at a rate inconsistent with the Fed’s 2% inflation target.

We should not expect this kind of hawkish data flow to change anytime soon, which supports our expectation of a series of at least three and likely four 50bp hikes. Powell will make this clear at tomorrow’s press conference. My guess is that this will be a sobering meeting for the Fed where everyone comes to terms with a series of 50bp hikes and the likelihood that rates will need to move substantially beyond the current long-run estimate of the neutral rate, 2.25-2.5% (which simply brings the Fed closer to the market). That is the hawkish message I think Powell will want to deliver. That message, however, may get lost if Powell pushes back on the idea of a 75bp rate hike at the June meeting. I think Powell will not want to endorse a 75bp move at this point, and instead would offer the option of the series of 50bp rate hikes continuing through the end of the year if the data provides no relief by the third quarter of the year.

The Fed is likely to see multiple problems with escalating to 75bp moves. First, it will be hard to get a consensus on board with what will be seen as a panicky move when, realistically, it is too late to panic. Second, the Fed needs to get some more clarity on the persistence of inflation at the end of this year. The Fed won’t be under the illusion that it can rapidly bring inflation down to 2% and will instead leverage the “forecast horizon” of three years on the hope it can slowly take the heat out of the economy. I don’t think that’s how it will work, but the Fed needs to at least try to avoid a recession. That argues against going too hard at the front end of the cycle. Third, the Fed can’t front load rate hikes too much because the data will demand the Fed keep hiking rates. The Fed can’t just hike rates to neutral and then sit on its hands when hawkish data keeps rolling in the door. It would be hard, if not impossible to communicate, that the Fed is stepping down to 25bp hikes (from anything greater than 50bp increments), or even to pause when unemployment keeps falling. The Fed needs to establish a pace of rate hikes that allows it to keep moving forward.

That said, as I wrote for Monday, the risk is that Powell says something like “all options are on the table.” If Powell doesn’t put up any guardrails despite knowing that market participants are focused on the question of 75bp, I think markets will see that as clearing the way to price in 75bp for the June meeting. If market participants subsequently conclude that 75bp is an admission on the part of the Fed that it can’t avoid a recession, I think the inverted yield curve story comes back into play.

Bottom Line: The speculation over a 75bp move makes this a challenging press conference for Powell. 

Back to list