Digesting the Fed's Message

The stock market had a hard time adjusting to the FOMC message last week.  While the market first reacted positively to the less-than-feared hawkish policy stance, it more than gave back Wednesday's relief bounce on Thursday and Friday as it presumably focused on Fed's intent to slow the economy or on the risk that the Fed's announced tightening path would be insufficient to bring down inflation.  

Fed Chair Powell announced the Fed's intention to hike by 50 BPs and reduce the Fed's balance sheet at the next several FOMC meetings.  So, there is little, if any, uncertainty regarding monetary policy through the Summer.  Barring extraordinary events during this time, the main question for the markets will be whether US economic data increase the odds that the Fed will achieve its goals of moderate growth and 2% inflation without having to tighten much more.  The data will have to indicate both slower growth in aggregate demand for goods and services as well as for labor.  Most importantly, increases in labor costs and core prices need to slow further.

The Fed's approach puts a lot of weight on financial markets to reach these goals.  Powell said at his news conference that reducing the Fed's balance sheet is meant to lift longer-term yields as a channel to restrain the economy.   To the extent that higher yields hurt demand, there is less pressure on stocks or the dollar to do so.  Nevertheless, economic growth and inflation may have to fall below the targets, that is overshoot to the downside, before a sustained stock market rally is possible.

Friday's April Employment Report had a mixed message with respect to the Fed's goals.  The jobs data were strong and Total Hours Worked looked to be on a path to match the increase seen Q122.  So, this side of the Report underscored the need to apply further restraint to slow the economy.  In contrast, there were indications that wage inflation continues to be contained.  The 0.3% m/m increase in Average Hourly Earnings was less than the 0.4-0.5% seen for the most part since last Spring.  And, the Unemployment Rate held steady at 3.6%, despite the large increase in Payrolls.  The broadest measure of labor market slack -- U6 -- edged up.

The Q122 Productivity/Labor Cost Report also suggested that labor cost inflation is contained.  Compensation/Hour rose only 3.2% (q/q, saar).   This pace is well below the 5.6% seen in 2021 and in line with the pre-pandemic range.  While the Q122 Employment Cost Index was high, its fixed composition of occupations may be masking a shift by companies to use lower-paid positions to hold down labor costs -- possibly a reason for the softer Labor Cost data.  The drop in Q122 Productivity should be ignored.  It resulted from what was likely a mis-timing of imports, which depressed GDP (as I argued in last week's blog).

This week's April inflation data could add to evidence that inflation is stabilizing -- and could stabilize the markets.  Consensus looks for +0.2% mm for the Total CPI and +0.4% for Core.  A 0.4% print for Core would keep it below the 0.5-0.6% range seen from October 2021 through February 2022.  Moreover, the risk is for a lower-than-consensus Core CPI.  The Total will be held down by a drop in gasoline prices, which is one-off (so far) and old news.  Consensus also expects a slowdown in the PPI, both Total and Core.  And, April Import Prices may show the dis-inflationary effects of the stronger dollar.