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What had Powell worried?
A recap of the last the Fed Meeting of the Year - Dec 2022
We got the hike of 50bps that we expected. There was nothing new there.
We got the Summary of Economic Projections that showed the median rate for next year move up to 5.1%. That’s a Fed Funds Rate of 5%-5.25%. This is exactly the number I arrived at in my last article.
But, once the Fed Chair’s press conference, he seemed visibly nervous. He seemed worried.
What do I think had him worried?
The threat of a wage spiral.
I’ve discussed the wage spiral before and so has he. Chair Powell has mentioned time and again that he didn’t think that wages were inflating out of control.
But, this time around, he made it quite clear that the wages were the largest portion of the inflation number and wages are still going up. And without an increase in unemployment, this will likely continue to drive inflation.
According to the Fed Chair, with the supply and demand imbalance in the labor market, workers remain unavailable. So, companies are already running on fewer workers than required and don’t want to layoff anymore (other than the tech sector).
This will put upward pressure on wages as companies want to retain workers and cover their cost of living because of higher prices. This in turn will lead to companies passing on those hire costs. The classic wage spiral.
Despite cooler than expected inflation numbers, the Fed Chair expressed not seeing inflation where they want it to be and it didn’t feel like he was convinced that inflation was becoming entrenched in the minds of people.
And that is the other big fear.
As Volcker pointed out: When people begin anticipating inflation, it doesn't do you any good anymore, because any benefit of inflation comes from the fact that you do better than you thought you were going to do.
What were the Inflation Numbers?
Well CPI, did decline on a headline basis but much of the services and core numbers still remains sticky. As does food inflation.
And then we have the PCE data - which was of more concern to the Fed. 55% of the PCE is non-core services and this is where they are afraid that inflation will either continue to increase or not reduce enough.
The Fed’s Revised Projections
Let’s take a quick look at the Fed’s revised projections. All the projections have become worse since the September projections.
The Dot Plot - which shows us what the Fed’s median projections are for interest rates. The median is now at 5.1% from 4.6% in Sep.
The Other Projections
For 2023, they expect:
Lower GDP at 0.5% now vs. 1.2% previously
Unemployment at 4.6% vs. 4.4% previously
PCE Inflation to come down to 2.1% by 2024
No rate cuts for 2023
No change to the 2% inflation target
I don’t think this was the meeting everyone expected yesterday. I don’t think people thought the Fed will hawkish even after two inflation prints showing declines.
But, as I said in the beginning, the Fed is not happy with the rate of change of inflation and there is still the possibility that inflation plateaus from there if wages continue to stay high.
They’re also considering that Shelter Inflation will only start to come down by mid-2023. I had projected May 2023 in my earlier article. So, they’re not very optimistic about this either.
Financial conditions have started to ease, and this is not helping the Fed’s case of fighting inflation. I don’t think the market still believes that the Fed will do what it takes. We saw people “buying the dip” again.
My view is that this time the Fed will not make the mistake of easing too soon. They probably will tighten into a recession, i.e., hard landing and probably will over-tighten.
Paraphrasing Chair Powell from yesterday’s meeting:
Financial conditions fluctuate… but they should reflect monetary restraint.
In other words… stop the euphoric buying!
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