Stock Recovery to Continue, Evaluating Fed Policy

The stock market is likely to continue to recover, albeit not necessarily smoothly, through April for several reasons:  /1/ The Fed has signaled a gradual, measured approach to tightening, with the next FOMC meeting in early May.  /2/ A negotiated end of the Russia/Ukraine war and a new Iranian pact are reported to be possible soon.  They could push down oil and other commodity prices -- assuming OPEC doesn't offset with output cuts.  /3/ Q122 corporate earnings, to be rolled out in April, are expected to be decent, up about 5% despite tough year-ago comparisons.

Last week's FOMC results have received criticism by some economists for not being anti-inflationary enough.  Some, like Larry Summers, say the Fed's Central Tendency forecast of continuing above-trend growth and slowing inflation is not credible.  History, they say, suggests that below-trend growth with a concomitant rise in the Unemployment Rate is needed to bring down inflation.  They are right, but with several caveats.  /1/ If supply constraints end, prices could fall.  /2/ If oil prices fall, so would transportation costs helping to hold down the prices of many goods and services.  /3/ A flattening in the Unemployment Rate could temper the rate of increase in wages.  /4/ Some of the historical evidence of run-away inflation resulted from structural features that are different now.  For example, the run-ups in inflation in the late 1960s and late 1970s were aggravated by COLAs which resulted in a wage-price spiral.  They are not prevalent now.  

To be sure, with shortages restricting growth in a number of important industries, the short-term "trend growth" rate is lower than the Fed's 1.8-2.0% long-term trend estimate.  So, it would require a sharper growth slowdown than otherwise to bring down inflation.

Fed Chair Powell suggested another reason why the Fed's forecasts are not unreasonable.  He pointed out that demand for goods and services and for labor are well in excess of supply.  If tighter Fed policy eliminates this excess demand, then actual economic growth may not be hurt much while inflation pressures are reduced.  This is an interesting argument, but not necessarily correct or, at the minimum, difficult to realize.   Measures of excess demand worth following are Job Openings, Quit Rate, Inventory/Sales Ratio,  Unfilled Orders, and Supply Delivery Time.  If they show some relief from excess demand -- and inflation begins to moderate, then Fed officials could feel more confident about its gradual approach to tightening.  Powell and other Fed officials are scheduled to speak this week and may highlight these ideas.