Will The Fed Tighten?

The stock market's concerns about the fall-out from the Iranian war are spreading to fears that the war's inflationary consequences will trigger a Fed tightening at some point.  Fed Chair Powell may have stoked these fears by mentioning that the possibility of a tightening at some point was discussed at the FOMC Meeting although not viewed as likely by most participants.  While the Fed will more likely remain on hold, the markets -- stocks and longer-term Treasuries -- may continue in anti-inflation modes in its place.

The main thrust of Powell's post-meeting news conference was the huge uncertainty surrounding the possible fall-out from the war.  At this point, it is unclear whether the price spikes precipitated by the war will be temporary or whether they will spur a more serious wage-price spiral.  Powell acknowledged that the jump in energy prices will not only boost the Total PCE Deflator but also Core as companies pass them through.  This boost, however, could be one-off.  Not having a clear read on the inflationary implications beyond the initial shock and potentially one-off pass-throughs,  Powell stated that steady monetary policy is appropriate.

A steady policy is likely to remain appropriate for at least several months, since uncertainty about the nature of the war's fall-out will probably not dissipate quickly.  However, the impatient markets may force the Fed's hand.  Upcoming price and wage data will be important for the markets, even though they may be too early to be conclusive about the war's consequences.  Powell said the Fed staff looks for the February Total PCE Deflator to print a steady 2.8% y/y and the Core to slip to 3.0% from 3.1%.  These estimates imply m/m increases of 0.4% for Total and 0.3% for Core.  These seem a little high, based on the February CPI (0.3% m/m Total and 0.2% Core).  However, compositional and weighting differences could be behind the Fed staff's high estimates.  The February PCE Deflator will be released April 9.

Wage data will be important, too.  This week's release of the Q425 Productivity/Labor Cost Revision should show lower productivity and higher Unit Labor Costs than in the advance report, based on the downward revision in Q425 Real GDP (to +0.7%, q/q saar, from 1.4%).  Consensus looks for Productivity to be revised down to 2.5% (q/q saar) from 2.8% and Unit Labor Costs revised up to 3.3% from 2.8%.  Compensation/Hour would be revised to 5.8% from 5.7%.  The latter, although high, could be chalked up to the typical volatility in this data series.  The y/y should be moderate .  Nevertheless, the upward revisions to labor costs could fan market concerns.

The other wage data to be released soon will be Average Hourly Earnings (AHE) in the March Employment Report, due April 3.  AHE printed a trend 0.3% m/m in February.  

The most important price news will be oil prices.   These should be dependent on developments in the war.

Besides inflation data, labor market data also will be important.  A Fed tightening may become more of a possibility if the Unemployment Rate moves down to the 4% or lower level.  Conversely, it may become less likely if the Rate rises.  At this point, the Unemployment Claims data do not suggest a big move in either direction, with an increase in the Rate perhaps more of a risk than a decline.