Raising the key bid by 50 bp and by promising other similar increases in June and July, the Fed has said it wants to calm the economy overheating, as evidenced, for example, by rapid wage growth. This is usually a sign that all the potential workforce is busy. There is no such thing today. Many workers have not yet returned to the labor market. Their number is estimated at 5 million compared to the trend towards Covid. If this gap continues to fill in the coming months, it will undoubtedly be enough to ease wage tensions without experiencing a recession.
US focus Bruno Cavalier, Chief Economist, and Fabien Bossi, Economist
For most of 2021, the Fed believed that the inflation shock would be remedied without the need to tighten monetary policy too quickly. The thesis of transitional inflation was supported by various arguments. The Fed changed its mind when it emerged that the labor market was moving toward overheating, with no hope of a rapid weakening. The Labor Cost Index (ECI), which had been in place until then, accelerated in the third quarter of 2021, especially in the leisure and hospitality sector, which was punished more than others for lack of workers. In the first quarter of 2022, ECI continues to move above its past trend (schedule). Other indicators, hiring, dismissals, vacancies, etc. confirm that at the beginning of the year the labor market remains very tense.
There are two ways to explain this overheating. The first follows the usual approach of the Philips curve. Wage pressures are the result of too low a unemployment rate compared to its natural level, as the labor factor is used at full capacity and even more. If so, there is no other way to calm the overheating than to slow the economy to such an extent that unemployment rises. In the history of US cycles, there has never been a case of unemployment rising without being linked to a recession. Those who announce a hard landing put themselves in this perspective. Another approach considers the specifics of Covid shock. Unexpectedly, a significant number of workers left the labor market due to exogenous reasons, obligations of imprisonment, illness, cessation of migration flows, and so on. A year ago, almost 10 million people were still married. Since then, this gap has narrowed. The rate of job creation was four to five times faster than under normal recovery conditions. This inevitably creates wage friction. According to our estimates, as of March 2022, the labor shortage is about 5 million compared to the trend towards Covid (schedule). In part, this gap is certainly due to early retirement, which is not so easy to return, but the rest can be filled in the coming months. This will reduce the pressure on wages, not necessarily a very restrictive monetary policy. This is the central thesis of the Fed. He will judge the future.
In April, procurement managers’ confidence indices fell slightly, but still exceeded the pre-pandemic level (Table). In the industry, surveyed companies continue to report high demand, on the one hand, but supply constraints on the other, which helps maintain price pressure. Several affiliates point out that restrictions imposed in China in March and April pose a risk to raw material supplies at the end of the 2nd-beginning of the 3rd quarter (however, tensions in the automotive sector appear to ease with sales resuming in April). In the service sector, supply constraints are mainly related to labor shortages.
In March, for the second month in a row, real consumer spending increased slightly (+ 0.2% m / m after + 0.1%). They even fell on the “goods” component, but more than offset by the “services” component. Is this the first sign that a sharp rise in prices tends to affect costs, not just consumer morale? The level of savings continued to fall to 6.2% of disposable income and fell below the level before the pandemic. This suggests that households are “immersed” in surplus savings accumulated in 2020-2021 to offset the shock with their real income.
Monetary and fiscal policy
During the May 3-4 meeting, the FOMC raised the key interest rate range by 50 bp. from 0.25% -0.50% to 0.75% -1.0% according to what was previously announced for several weeks. The vote was unanimous. The FOMC has also confirmed that it will quickly begin the process of deflating its asset portfolio. From June 1 and for the next three months, maturing securities will be reinvested only in excess of the maximum allowable amount of $ 47.5 billion per month, broken down by 63% for treasury securities and 27% for MBS. Starting in September and indefinitely, the ceiling will be doubled to $ 95 billion a month for the same distribution key. The ceiling will always be reached for treasury bonds, but not necessarily for MBS at the beginning of the process. At cruising speed, the Fed’s balance sheet will shrink by $ 1.1 trillion a year. During the pandemic crisis, it grew by more than $ 4 trillion.
At a news conference, Jerome Powell noted that at the June 15 and July 27 meetings, the FOMC was inclined to continue raising the key rate to 50 bp. (He rejected the case of an increase of 75 bp, which has worried market participants in recent days). At the same time, monetary policy would be at the bottom of the neutral zone, which is usually determined by a key rate of 2% to 3%. Just seven weeks ago, the FOMC’s target was set to reach just 2% by the end of 2022. Powell remained elusive for subsequent meetings as he waited to see how the US economy would react to the various shocks of the moment (rate hikes, supply constraints, uncertainty). The central scenario remains a slowdown without a recession (soft landing), which means that inflation will return without the need for restrictive monetary policy. The Fed chairman, however, does not rule out that he will get there if necessary.
Continuation of this week
Undoubtedly, the April 11 consumer price report will be examined for signs that inflation may have finally peaked in the United States (See Focus-US from April 14). Last month, in addition to energy prices, the monthly growth rate slowed down. This must be confirmed within a few months to lead to a real reduction in inflation. The basic effect will work favorably in April. Just a year ago, CPI-core jumped 0.9% m / m, which is a record in this cycle, while its average growth in recent months was only 0.5%. In addition, gasoline prices fell from mid-March to mid-April (until some recovery), which should also affect expected inflation, which fell by 8.5% in March to about 8% in April.
As usual after the FOMC meetings, the media will encourage its members to give their assessment of the situation. We will pay particular attention to the interventions of those considered “hawks”, namely James Bullard (St. Louis Fed), Loretta Mester (Cleveland Fed) and Christoph Voller (Board of Directors).