The stock market faces the midterm elections and October CPI this week. Historically, stocks tend to rally after these elections. But, this week's CPI release is expected to show that inflation remains a problem. Along with fears of an upward-revised 2023 endpoint for Fed tightening at the December 13-14 FOMC Meeting, the stock market may have trouble following the historical pattern this year. To be sure, a below-consensus CPI can't be ruled out, in which case the seasonal pattern could persist for awhile.
The stock market is now focused on the endpoint as well as the speed of Fed tightening, after Fed Chair Powell emphasized the former. The speed, however, still could be more important from the stocks' perspective at this point. A slower speed reduces the risk of a market or financial crisis (such as what happened in the UK). It also reduces the risk the Fed will overshoot tightening and precipitate a recession. The endpoint is far down the road and could change.
A potential problem, however, is that a gradual pace of tightening may not be enough to achieve the Fed's goal of lower inflation. This was the case in 1994, when Greenspan tried to slow the economy with a string of 25 BP hikes. The economy slowed only after he shifted to larger hikes. Ironically, a slower pace of hiking could result in a higher-than-otherwise endpoint.
The Fed's shift to emphasizing the endpoint as well as the speed of tightening feels like a compromise between FOMC members who are focused on eliminating inflation at any expense (eg, Powell) and those who are concerned about fall-out from continuing sharp rate hikes (eg, Brainard). Powell suggested the year-end endpoint for 2023 will be raised from September's 4.4-4.9% in the revised Central Tendency forecasts at the December 13-14 FOMC Meeting. Some economists, like Larry Summers, thinks it should be at least 6.0%.
A silver lining of an endpoint forecast is that it is not written in stone -- as evidenced by the continuing revisions to the Fed's Central Tendencies. December 2023 is a long way off, and many things could happen along the way to undermine the forecast. So, while the markets will adjust to the new forecast, they will likely do so with some tentativeness. Indeed, the funds rate may never reach the forecast if Powell's hawkish rhetoric directly impacts economic decision making and activity.
Although the Fed is focused on wage inflation as a culprit behind the high price inflation, this may not be the main problem boosting labor costs (see table below). Compensation/Hour -- the broadest measure of labor costs per worker -- is already settling back to the range seen before the pandemic (3.5% so far in 2022 versus 2.0-4.3%, avg 3.1%, over 2015-2019). The real problem is the weak Productivity Growth (-3.2% so far in 2022). It was responsible for the jump in 2022 Unit Labor Costs.
Labor hoarding by companies may be responsible for the decline in Productivity -- despite all the talk of labor shortages. Companies have too many employees for current production levels. If so, companies' efficiency drives, as seen in a recent pickup in hiring freezes and firings, could solve the productivity problem by eliminating excess labor per unit of output. It also could help cut price inflation if companies had passed on the costs of holding excess labor. This could be the main way prices are held down rather than by slowing wage rate increases. The latter remains a problem, as seen in the 0.4% m/m increase in October Average Hourly Earnings. It kept them on the trend, albeit too high, seen since the start of the year.
This understanding of the labor cost/price inflation nexus suggests that a pass-through of higher aggregate labor costs has played an important role in explaining the surge in inflation, not just the speedup in hourly wage rates. It implies that the trade-off between Unemployment Rate and Wage Inflation (the Phillips Curve) may be less significant in the battle against price inflation than most think. Instead, a decline in headcount at companies could directly hold back price inflation. Conceivably, this channel could result in a faster decline in inflation than many expect.
A speedup in productivity in Q422 is suggested by the October Employment Report. Although Payrolls were strong, Total Hours Worked only edged up and are 1.1% (annualized) above the Q322 average. Similar m/m gains in November and December would put the Q422 average about a percentage point below the Q322 pace. Meanwhile, the Atlanta Fed model's early estimate is for a speedup in Q422 GDP Growth.
Labor costs are not the only factor boosting price inflation. Housing rent is another. It has begun to fall, but at most should slow a bit in the October CPI because of the way it is calculated. Even so, it would take some softening in other components for a sub-consensus print. Airfares are a big uncertainty, however. Otherwise, the consensus estimates of +0.7% m/m for Total and +0.5% for Core seem reasonable. The most important component could be Core less Shelter, as it would show whether the underlying inflation excluding rent is slowing. So far it has not. It was steady at +0.5% in September, staying at the 0.5% m/m average seen since January.
(Q4/Q4 Percent change)
Compensation/Hour Productivity ULC Core CPI
2015 2.6 0.8 1.8 2.0
2016 2.0 1.3 0.6 2.2
2017 4.3 1.4 2.9 1.8
2018 2.6 0. 9 1.6 2.2
2019 4.2 2.6 1.5 2.3
2020 9.9 4.7 4.5 1.6
2021 5.3 1.9 3.2 5.0
2022 * 3.5 -3.2 7.0 6.5
Q322 ** 3.8 0.3 3.5 6.4
ULC = Unit Labor Costs = Compensation/Output (essentially equal to the percent change in Compensation less percentage change in Productivity)
* annualized change over first 3 quarters of 2022
** q/q saar
No comments:
Post a Comment