Chief Economist Scott Brown discusses current economic conditions.
In his monetary policy testimony to Congress, Fed Chair Pro Tempore Powell solidified market expectations that the Federal Open Market Committee will raise short-term interest rates by 25 basis points on March 16 (and not by 50). The February employment data were strong. The February Consumer Price Index (report arriving March 10) should continue to show elevated inflation. The FOMC is now expected to raise rates at every policy meeting this year (but will pause when the reduction in the balance sheet begins).
Nonfarm payrolls rose more than expected in February (+678,000), partly reflecting a rebound from Omicron-related constraints in January. The unemployment rate fell to 3.8%, close to where it was before the pandemic (a 3.6% average for 4Q19). Average hourly earnings were flat, but that reflects compositional effects. Job gains were stronger in lower-paying service industries (and in lower-paying positions within other industries). Inflation reduces the purchasing power of wages, but aggregate wage income rose 0.8% in February, up 10.8% from a year ago, consistent with a moderate pace of consumer spending growth.
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In arriving at their monetary policy decisions, the FOMC considers a wide range of anecdotal information (in addition to the hard economic reports). The Fed’s Beige Book noted that “widespread strong demand for workers remained hampered by equally widespread reports of worker scarcity.” Prices charged to customers “increased at a robust pace across the nation.” Firms reported an increased ability to pass on higher costs to consumers and “in most cases, demand has remained strong despite price increases.” The FOMC is justified as it takes the foot of the gas pedal, but is far from slamming on the breaks just yet.
The labor market is a lot more flexible than the unemployment rate would suggest. There are many potential workers on the sidelines who could be lured into the workforce if offered a decent job and a good wage. Labor force participation (62.3% in February) remains below its pre-pandemic level (63.3% in 4Q19), but the gap is closing. According to Fed research, most of lower participation at the end of last year was due to retirements, half of which were expected. The rest, excess retirements, partly reflects older workers who were wary of the virus, but the recent data suggest that many of these people are returning.
A big worry is the mindset of higher inflation, which makes it easier for firms to raise prices whether justified by higher costs or not. Price increases have broadened across categories. Corporate profit margins remain wide.
According to Powell, “we continue to expect inflation to decline over the course of the year as supply constraints ease and demand moderates because of the waning effects of fiscal support and the removal of monetary policy accommodation -- but we are attentive to the risks of potential further upward pressure on inflation expectations and inflation itself from a number of factors.” And if inflation doesn’t moderate as anticipated “we would be prepared to move more aggressively by raising more than the normal quarter percentage point.”
Recent Economic Data
The February Employment Report was strong. Nonfarm payrolls rose by 678,000, a 6.8 million increase over the last 12 months, with broad-based gains across industries. Average hourly earnings were flat (+5.1% y/y), reflecting faster job growth in lower-paying positions (mostly in services). Average hourly earnings for production workers rose 0.3% (+6.7% y/y).
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The unemployment rate fell to 3.8% (vs. 4.0% in January and 6.2% a year ago). Labor force participation improved, with some signs that early retirees are returning to the workforce.
Unit motor vehicle sales fell to a 14.1 million seasonally adjusted annual rate in February, from a 15.0 million pace in January (boosted by the seasonal adjustment) and 16.9 million a year ago.
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The U.S. merchandise trade deficit widened to another record, $107.6 billion in the advance estimate for January, from $100.5 billion in December. Exports fell 1.8% (+15.3% y/y). Imports rose 1.7% (+19.7% y/y).
The ISM Manufacturing Index rose to 58.6 in February (vs. 57.6 in January). The ISM Services Index fell to
56.5 (from 59.9 in January and 62.3 in December). Both reports indicated strong demand, but with ongoing supply issues (including capacity constraints, delivery delays, and labor shortages).
The opinions offered by Dr. Brown are provided as of the date above and subject to change. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.
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