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The Federal Open Market Committee raised the federal funds interest rate to an upper bound of 5% today, following their March meeting. Their press release indicates ongoing concerns that robust spending, tight labor markets, and still-high inflation justify the rate hike. While the Fed acknowledged concerns that recent banking problems are likely to result in somewhat tighter lending conditions, they clearly believe that inflation trumps these concerns--at least for now. The Fed's two-pronged approach to the twin ills of inflation and banking sector security seem appropriate. Over the past week, the central bank has accommodated the extra cash needs of financial institutions through a special program for Silicon Valley Bank and other directly affected institutions, and it has permitted a high volume of general financial institution borrowing at the discount window. According to the AP, the Fed lent about $300 billion to financial institutions over the past week, more than half of that at the discount window. This meets the Fed's need to provide liquidity in times of crisis. Today's interest hike need not be seen as inconsistent with this goal. While it is true that the financial turmoil has likely raised the cost of finance for some borrowers, estimates of the effect are all over the place. (Chairman Powell suggested this is perhaps equivalent to a rate increase or more.) Today's quarter point rise sends the signal that inflation is still job one, but the increase is small enough not to be destabilizing. We and the Fed will be watching real economic activity and banking stability closely before the next FOMC meeting, scheduled for May 3.

Fed Chairman Jerome Powell gave his semi-annual report to Congress today. He was clear that further rate hikes are coming, given recent data that indicates persistent inflation in services and renewed concerns about the ultra-tight labor market. Financial markets reacted by raising their expectations of where the federal funds interest rate will peak this summer, at 5.75%. Source: https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html You might ask "so what"? Well, these revised expectations of coming Fed policy caused financial investors to bid up short-term interest rates substantially later in the trading day, and in fact to a point where short rates were much higher than long-term interest rates. Such a "yield curve inversion" is often seen as an indicator of a pending recession. We get another jobs report on Friday and CPI for February next Tuesday, which may tell us more about whether the recent upward pressure on prices is likely to continue. The Fed has been raising rates at the most rapid pace since the early 1980s to slow demand and therefore take pressure off prices. The biggest effects so far have been on housing markets and manufacturing, with consumer spending still expanding at a moderate rate. The next meeting of the Fed's policymaking committee is March 22. bg 2/7/2023

Continuing in the “pick a survey, any survey” vein, labor market data out today are playing different tunes, depending on what you are listening for. Different strokes for different folks The Bureau of Labor Statistics' monthly labor report includes results from two labor market surveys for May. The first, the establishment survey, showed robust growth in filled jobs, up 339,000 from April, nearly twice the consensus among forecasters. This strong job growth suggests that at least for now businesses overall are happy to keep adding workers to their payrolls. Strength was not uniform across industries, with some service sectors adding workers at a rapid clip, softer conditions in construction, and net job losses in manufacturing, an area that has been essentially in recession for a half year now. BUT, results of the separate survey of households were more downbeat. The number of people saying that they were employed fell by 310,000. With the size of the labor force holding steady, that pushed the unemployment rate up from 3.4% in April to 3.7% in May. Should I stay or should I go now? The two surveys—one of businesses and the other of households—tend to track each other fairly closely over the medium-term, but they can diverge in the short run. Not only do they come from different sources, but the nature of the data they cover is somewhat different. The establishment survey only covers payroll employees of businesses, while the household survey includes self-employed people. That turned out to be an important difference last month. In the household survey, business employee numbers rose, but the level of “unincorporated self-employment”—which includes independent contractors and some small businesses—fell sharply. It’s hard to know what to make of this. Is the drop in this category a leading indicator of softening activity in personal service areas? Or are we just seeing a readjustment as people are able to pivot away from pandemic-era gig work to "regular" business employment? There is not sufficient detail in the survey to tease that out. Other data in the labor report reinforce the notion that labor markets are not as tight as the payroll employment numbers suggest. Importantly, wage growth continued to ease slightly, although it still remains at a high level that is inconsistent with a balanced labor market and medium-term price stability. What’s the Fed gonna do, gonna do with it? Today’s labor market report one of the last major pieces of data before the Federal Open Market Committee meets June 13-14. (The May CPI will come out the day of the meeting.) The question is whether the gangbusters payroll jobs data will be sufficient to prompt another quarter-point interest rate hike. One might think so, since other recent indicators—like PCE inflation data—have also come in strong. But comments by Fed officials have broadly hinted at a rate-hike pause in June to see how the past year’s monster rate increases are feeding through to the broader economy. And the Fed these days seems to want to avoid surprising markets if it can. So a June pause may be baked in to Fed thinking. But don’t be surprised if the Fed is back to playing more ominous music in July.

The Federal Open Market Committee meets next week. Financial markets overwhelmingly expect a quarter point hike in the federal funds rate, and that this will be the last hike of the current tightening cycle. The Federal Reserve is the country's main inflation fighter. It does this primarily by raising interest rates to discourage borrowing and spending. The Fed's challenge is to slow spending just enough to reduce demand pressures that push up prices, but not so much that it causes a recession—a period of broad contraction of economic activity. The Fed began raising rates last March, and its upper bound for the federal funds rate now stands at 5%. There are plenty of reasons that the Fed should stop hiking now: Some bellwether sectors are already in recession: Real estate sales have tumbled as interest rates soared over the past year, and home prices have moved lower, with sharp drops in some markets. (February Case-Schiller data show home prices may be starting to stabilize). Manufacturing is also in recession. Measured by the Institute for Supply Management’s manufacturing index, the sector has been contracting by widening margins since last November. There are emerging indications of slowing in the broader economy. Increments to the non-farm payroll job base, while still healthy, have been trending lower, and job openings, which have been exceptionally high, have receded somewhat. While the unemployment rate remains near multi-decade lows, it has begun to turn up for the most vulnerable groups, in particular for hispanics. Small firms are shedding workers and having difficulty meeting fixed costs like rents. Consumer spending, which has been strong, may also be starting to crack: Retail sales have been slowing since last summer, and have been contracting for more than a year when adjusted for inflation. Overall consumer spending is still expanding year-on-year, but has declined recently. Forward-looking indicators are signaling a coming recession. The Conference Board’s Leading Economic Indicators index has moved into the deep negative territory usually associated with recessions in the past. New orders for durable goods have softened. And the forecasts of FOMC members themselves imply a mild recession later this year and early 2024. The recent Silicon Valley Bank event has worsened credit conditions that were already becoming more restrictive. The extent of credit tightening that has now occurred is consistent with that seen prior to past recessions. Fed Chairman Powell has acknowledged that recent liquidity problems are equivalent to one or more Fed interest rate hikes. Progress fighting inflation suggests that the interest rate hikes to date have probably been sufficient to get us to 2% inflation over the next few years. Pick your measure of inflation, and it has receded steadily since the middle of 2022. Consumer price index (CPI) inflation has receded from about 9% in June to 5% in March, and the Fed's preferred personal consumption expenditure (PCE) inflation has receded from 7% to just over 4%. Disinflation has proceeded further than suggested by annual statistics. We can see this by comparing average prices to those that prevailed six months earlier (expressed at an annual rate). CPI inflation by this measure was running at 3.6% in March. Inflation remains above the Fed's 2% target, but it is clearly headed in the right direction. And one substantial driver of current inflation, housing and utility costs, has turned the corner and will decline further as falling rents feed through to lower measured shelter inflation. So why won't the Fed pause interest rate hikes now? Inflation for services other than housing and utilities continue to run hot, rising at an annual rate of 4.7% over the past six months, accounting for more half of all inflation. So far, there is no sign of this tailing off. These are labor intensive sectors, and with average hourly earnings still running above 4%, the Fed will be concerned that labor costs could keep this category of inflation high for some time. This could mean that the overall inflation picture is not yet consistent with convergence to its 2% target. But the Fed is likely putting too much weight on service inflation, considering the weakening we are seeing in the broader economy. In particular, the strength in consumer spending is waning. Today's personal consumption expenditure report shows that inflation-adjusted consumer spending declined in both February and March. As consumer spending slows further in coming months, weaker demand will cause wage growth and service inflation to slow, moving us closer to the Fed's long-run 2% inflation target. If inflation proves more durable than expected, the Fed would still have time to act. Because expectations of future inflation remain muted, the risk that high inflation will become entrenched in the economy is limited. The Fed may argue that it is being conservative by continuing to raise interest rates until there are convincing signs of receding service inflation. But this downplays the heavy costs that households will have to bear if high rates tip us into an unnecessarily deep recession. In that case unemployment could rise more sharply than needed, with all the attendant personal and social burdens that that imposes. Better for the Fed to keep its powder dry for a few months to see if its past rate hikes bring about sufficient slowing to push us toward long-run price stability without extreme economic fallout.