Another Week of Russia/Ukraine and Impending Fed Rate Hike

The stock market should continue to be dominated by Russia/Ukraine developments this week, but also will likely have to contend with another high CPI report.  Despite the latter, as well as the strong February Employment Report, the Fed may very well opt for only a 25 BP hike at the March 15-16 FOMC Meeting.  Not only is there much uncertainty regarding Russia/Ukraine, but the resulting surge in oil prices could restrain US economic growth as it will act as a tax on the consumer.

The consensus estimate of the February CPI (+0.8% m/m Total, +0.5% Core) looks reasonable.  Besides the run-up in gasoline and heating oil prices, pass-through of the higher fuel prices to airfares and other goods and services could show up, as well.  Moreover, there could be residual start-of-year price hikes, particularly among components that are sampled bi-monthly.  These factors should more than offset a further softening in Used Car Prices.

The February Employment Report showed that the US economy retains a lot of momentum, so should be able to sustain a modest pace of Fed tightening.  Total Hours Worked in February are 4.4% (annualized) above the Q421 average, not much below the 6.0% Q421 pace (q/q, annualized).  This momentum risks slowing, however, as the surge in oil prices weighs on the consumer.  Oil prices are up about $50/bbl from their recent lows, amounting to the equivalent of a $300 Bn+ (annualized) tax hike.  While some of the drag should be offset by increased domestic oil production, this supply response is likely to be muted because of the anti-oil stance of the Biden administration.

The anomaly in the February Employment Report was the 0.0% m/m Average Hourly Earnings.  The surprising low print could have resulted from compositional shifts or some other technical factor, it also could have resulted from companies trying to hold down labor costs -- possibly by shifting to more part-time workers.  Whatever the cause, the flat AHE provides another reason for the Fed to take a cautious approach to tightening, giving more time to see if some of the recently high inflation unwinds as supply constraints ease.  

Aside from the specific reasons for the flat February AHE, some models offer a reason for wage inflation to slow somewhat.  These models say that wage inflation not only depends on the level of the unemployment rate but also on the latter's change.  So, with the unemployment rate having stopped falling as fast as it did through most of 2021, wage inflation could moderate.