Thus, Goolsbee has “put concerns about the job market aside”. His focus is on inflation.

As President of the Chicago District, Goolsbee is reacting to the observations and concerns of his Midwest constituents across Iowa, Illinois, Indiana, Michigan, and Wisconsin. He cited concerns about costs and affordability. However, the January Beige Book entry for Chicago did not describe any notable levels of concern as follows:

“Prices rose moderately on balance in late November and December and contacts expected a similar pace of growth over the next 12 months. Producer prices rose moderately. Nonlabor input costs rose moderately, with contacts highlighting higher costs for energy (particularly electricity) and raw materials. Manufacturing contacts continued to attribute some increases in raw materials prices to tariffs, while a few construction contacts reported little effect of tariffs on their operating costs. Consumer prices rose moderately, and one retail industry analyst said that to date about half of tariff-related cost increases had been passed through to consumers.”

These “moderate” observations from January are almost identical to the descriptions from the November Beige Book.

The Fed’s contacts in the Chicago district appear to support Goolsbee’s lack of concern for the labor market. They expect a slight increase in employment in the next 12 months. So far, gains in hospitality employment have compensated for further contraction in manufacturing employment. Employers are focused on replacing retirees and citing overall sufficient worker availability. In the CNBC interview, Goolsbee pointed squarely at the uncertainty driven by government policies as the source of employment weakness. The Fed cannot address this kind of uncertainty with lower interest rates; monetary policy acts in an economically cyclical way

The Fed is unable to address non-cyclical issues. Goolsbee suggests as much when he points out that “low hiring and slow firing is not what the business cycle looks like”. Instead, a business cycle features high layoffs along with low hiring.

Goolsbee’s observations and assessments clearly plant him firmly against rate cuts for the foreseeable future.

Conclusion

Goolsbee sounds about as entrenched in his position as are the most dovish members of the Fed who believe rate cuts are necessary to support the labor market. Thus, the stage remains set for growing acrimony as monetary policy moves cautiously ahead of the arrival of a new Fed Chair who presumably will be under orders to get rates much lower as a condition for the nomination. The jobs picture as outlined by Goolsbee will make such a dovish push quite difficult to explain.

So while it seems unlikely the Fed will deliver the surprise rate cut this January, I think the overall trajectory of a dovish bias for the Fed keeps expectations solid for an economy running on the hot side with policy combined with a surplus of fiscal stimulus. Thus, I continue to like the commodities portion of my shopping list for 2026.

The post The Fed’s Labor Market Divide Is Hardening Against Rate Cuts appeared first on Inflation Watch.

With so much dissension and disagreement in the Federal Open Market Committee (FOMC), the minutes of recent meetings have become more revealing. The minutes from the December Fed meeting shed more light on the character of those disagreements than Powell was willing or able to share at the press conference. During that press conference, Powell emphasized consensus amid uncertainty and portrayed disagreement within the Fed as a natural consequence of a multidimensional policy environment. Read alongside those remarks, the minutes reveal a more fractious narrative, one marked by deep and structural differences that are likely to shape monetary policy well into 2026. Powell framed disagreement as technical. The minutes suggest it is structural.

A Committee Without An Anchor

As a reminder, the FOMC members displayed striking dispersion with their votes. While the nine votes in favor of a 1/4 percentage rate cut were sufficient to carry the decision, the minutes indicated that a few of the yes votes came from FOMC members who “indicated that the decision was finely balanced or that they could have supported keeping the target range unchanged”. Two votes opposed the rate cut outright and wanted to leave rates unchanged. The third opposing vote wanted a 1/2 percentage point cut. Specifically, in favor were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Susan M. Collins; Lisa D. Cook; Philip N. Jefferson; Alberto G. Musalem; and Christopher J. Waller. Stephen I. Miran wanted the deeper cut. Austan D. Goolsbee and Jeffrey R. Schmid wanted no change.

Powell’s Consensus Narrative vs. the Reality in the Minutes

Powell framed the lack of unanimity as a question of risk-weighting rather than disagreement over fundamentals. “Everyone around the table agrees that inflation is too high and that we want it to come down,” he said, adding that officials also agree the labor market has softened. Where views diverge, Powell claimed, is “how do you weight those risks and what does your forecast look like,” describing the decision as a “close call” driven by the “complicated, unusual, difficult situation” tugging on the Fed’s dual mandates. Powell’s claim about inflation attitudes is particularly important given the Fed will likely spend a lot of time talking up its inflation-fighting credibility even as it cuts rates this year due to political and economic pressures.

The minutes suggest that the tension is forcing the Fed to confront a confluence of opposing economic views that resists clean consensus and raises the odds of persistent dissension. Importantly, a tension between inflation rhetoric and employment risk runs through the minutes.

Inflation: Confidence in Theory, Unease in Practice

Powell expressed confidence that inflation will continue to move lower over time. In aggregate, the minutes reflect that view. However, “a majority of participants remarked that overall inflation had been above target for some time and had not moved closer to the 2 percent objective over the past year”. The Fed’s staff reinforced these concerns by concluding that the upside risk to inflation has become more precarious given that inflation has remained above the Fed’s 2% target for four straight years. Still, some participants claimed that those upside risks have declined.

In a likely reference to the Fed’s Beige Book (which in 2025 was full of vivid descriptions of inflation pressures), the minutes reported that “some participants stated that their business contacts had reported persistent input cost pressures unrelated to tariffs”. Several of these participants in turn reported that “weaker demand limited the ability of some firms to raise prices or that business productivity gains might enable some firms to manage these cost pressures”. 

The minutes reported that “some participants highlighted the risk that elevated inflation might prove more persistent than expected”. These fears likely stem from the lingering and uncomfortable uncertainty about the ultimate impact of a fluid tariff regime. The minutes reported that a majority of participants expected disinflation in housing services to continue while a few participants also saw ongoing disinflation in core nonhousing services. As usual, this suggests the Fed finds plenty of comfort in the relatively tame long-term expectations for inflation based on survey and market data. As usual, these assessments suggest the Fed finds plenty of comfort in relatively tame long-term inflation expectations based on survey and market data.

If inflation will actually making a soft landing to the Fed’s 2% target in 2027 and 2028 as the current central tendency in the projections insists, the journey will likely continue to feature sticky inflation… and plenty of jawboning to convince financial markets the Fed will not allow tariffs, for example, to cascade into persistently high inflation. According to the minutes, “some participants noted concerns that a more prolonged period of above-target inflation could risk an increase in longer-run expectations”. Four years already seems like a prolonged period, so I am not convinced that a few more years above 2% will dissuade the Fed from continuing to cut rates to try to address weakness in the labor market.

Taken together, the minutes show a Fed that is far more concerned about labor-market fragility than its public messaging suggests. By incorporating that calculus, the bar for another rate cut looks lower than current market pricing implies”.

Labor Markets: Where the Fed’s Anxiety Really Shows

The FOMC sounded more unified about the employment picture. As a result, I expect in due time the Fed will give sway to cutting rates again sooner than later, as soon as January. According to the CME’s FedWatch tool, the current odds for a rate cut sit at a paltry 15% for the January 28th meeting, so I realize my perspective is an outlier. However, in a coming year that should deliver its share of outlier events, I think a January rate cut will be the least of the economic and financial surprises.

In December’s press conference, Powell acknowledged labor market softening. Powell said the Committee agreed that “the labor market has softened” and emphasized that employment faced “further risk”. However, he downplayed the urgency of the perceived deterioration. By contrast, the minutes uncovered some deeper anxieties about the employment picture and now give me further reason to believe in the high possibility for a January rate cut. For example, the minutes reported that several participants presented a case of potential signals of “greater fragility in the labor market”.

Why I am Expecting a January Rate Cut

The minutes reported that “participants generally assessed that, under appropriate monetary policy, the labor market likely would stabilize next year.” This conditional framing supports my expectation for more rate cuts than the market currently assumes. Notably, the central tendency of the Fed’s projections pegs 2025 as the peak year for unemployment. Any negative divergence from that assumption would strengthen the case for additional rate cuts.

Conclusion

The Fed as a group positions its statements for downside risks to employment and upside risks to inflation. However, the balance of its attention suggests the Fed is prepared to act as though inflation is well under control and employment is the more fragile component of the economic picture. I assume the stock market’s complete comfort with the current tensions comes from an abiding belief in the lower trajectory for interest rates. The market has already been gifted three rate cuts with the indices at or near all-time highs. The central tendency for rates in 2026 is 2.9% to 3.6%. The non-zero possibility that the Fed does not cut rates at all this year looks to me like window dressing meant to preserve the Fed’s inflation-fighting credibility.

I am betting on rate cuts to continue in January and an still positioned in the Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP) as a main hedge against the stagflationary potential for more rate cuts in the face of sticky inflation. GTIP currently yields 4.2% and gained 1.9% in 2025. GTIP is down about 17% from its 2021 all-time high.

Be careful out there!

Full disclosure: long GTIP

The post Lessons from the Fed Minutes: Why Division and Dissension Are Likely to Dominate Monetary Policy in 2026 appeared first on Inflation Watch.

I am tempted to say financial markets have already done the Fed’s work. However, it is very likely that the minute the Federal Reserve even hints that rate cuts could be delayed until next year, the resulting tantrum in financial markets could be epic. The Fed is loathe to disappoint markets, and the message from the last meeting and subsequently from Jerome Powell has been to promise a rate cut sooner than later. Financial markets have persistently focused on any and all dovish twinges in Fed-related pronouncements. For example, from Powell’s testimony to Congress on March 6th (emphasis mine):

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

Powell can insert all the standard caveats he wants. Markets read this statement as saying rate cuts are on their way!

A Nervous Bond Market

Yet, bond markets have been a little “nervous” all year. For example, the iShares 20+ Year Treasury Bond ETF (TLT) has trended downward (meaning higher bond yields) so far this year with lower highs and lower lows. From TradingView:

TLT is just a fresh low of the year away from finally catching the stock market’s attention again.

Copper, Lumber, and Oil – oh my!

The bond market has good reason for some jitters. Several commodities have sprung back to life this year. Copper miner Freeport-McMoRan Inc (FCX) is welcoming the upcoming Fed meeting with a 7+ month high. FCX is up 19.8% in less than two weeks. (FCX has been stuck in a trading range since the beginning of 2021).

Lumber bottomed out in early 2023. This month, lumber broke out above last summer’s high and is back to levels last seen in August, 2022.

Oil, everyone’s favorite non-core component of inflation, has been in “stealth” rally mode all year. The United States Oil Fund, LP (USO) looks ready to launch parabolically on the wings of rate cuts.

Where will these prices go with rate cuts? I vote higher.

The Golden Touch

Speaking of getting ready for rate cuts, gold, my favorite hedge enjoyed a spectacular (and overdue) breakout this month. SPDR Gold Shares (GLD) traded at an all-time high at its peak this month.

I like buying the dips in GLD going forward. The odds seem sufficiently high for the Fed to feel “forced” into easing into a sea of market liquidity.

Straining to See the Weakness in Labor Markets

So maybe the Fed can strain its economic gaze and find an excuse to do a “proactive” rate cut. The graph below shows the unemployment rate has likely bottomed out (left axis and blue line) Yet, it remains near historic lows. Initial unemployment claims have been trendless with a recent peak set last summer (right axis and green line). Finally, real GDP quarter-over-quarter growth has levitated in positive territory and for the last two years has defied overly persistent expectations for a recession (right axis and red line). From my perch, I see no excuse for a rate cut here, but perhaps I am not creative enough with the data.

Sources: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis.

The Stock Market’s Giddy Anticipation

The stock market’s giddy anticipation of rate cuts is poetic. The stock market has soared on loosening financial conditions and has been able to ignore just about any bad news the macro environment tries to toss out there. Recent successive all-time highs speak volumes to the buffer the Fed can enjoy if it so chooses to wait out the Presidential election before making changes to monetary policy.

Conclusion

With market breadth increasingly lagging the stock market’s ascension, I have been a skeptic about the overall rally for several weeks. The Federal Reserve is probably the last catalyst between now and the Presidential election that has a chance of validating my skepticism. If the Fed complies with the market’s giddiness, there is no telling how high the market could soar in coming months. If the Fed decides to wait things out, the stock market will lose a major contributor to the upward and higher fund. Then again, maybe the Fed pulls off a magical “hawkish rate cut” (one and done rate cut with a warning about the potential for inflation to rise from the ashes). The Fed could figure out just the right balance between disappointing the stock market and fueling ever increasing levels of speculation and higher commodity prices…

Be careful out there!

Full disclosure: long GLD

The post Financial Conditions Make A Monetary Roundtrip and Undercut the Need for Rate Cuts appeared first on Inflation Watch.

Monetary Policy Question and Answer with an AI

The following question and answer with the generative AI in NotebookLM is like a poor man’s substitute for the Fed’s official Q&A session. Each section of dialogue below starts with a quote from Fed Chair Jerome Powell, followed by my question, and then NotebookLM’s response. All quotes are verbatim with some caveats on NotebookLM’s response in curly brackets.

Powell: “We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.”

Me: “Does Powell express any confidence that inflation is on the path to meeting its objective of 2%?”

NotebookLM: “No, Powell does not express any confidence that inflation is on the path to meeting its objective of 2%. He says that the Fed will continue to raise rates until inflation is under control, and that the two conditions that would lead the Fed to stop raising rates are (1) if inflation is on a path to the Fed’s 2% target and (2) if the labor market is continuing to broadly cool off and achieve a 4% unemployment rate. He does not say that either of these conditions are likely or happening now.” {That second condition is not directly stated in the transcript. NotebookLM must have picked this up from an external commentary. A more accurate characterization would be to drop the specific, quantified unemployment target}.

Powell: “We are attentive to recent data showing the resilience of economic growth and demand for labor. Evidence of growth persistently above potential, or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.”

Me: “What evidence does Powell cite to demonstrate that recent data show the resilience of economic growth and demand for labor?”

NotebookLM: “Powell cites the following evidence to demonstrate that recent data show the resilience of economic growth and demand for labor:

• GDP growth: Powell cites the strong third quarter GDP figures as evidence that the economy is continuing to expand at a strong pace.
• Employment: Powell notes that the labor market remains very strong, with job openings and labor demand still clearly remaining very strong.
• Inflation: Powell acknowledges that inflation is still high, but he argues that the recent data show that inflation is beginning to moderate.”

Powell: “As for the Committee, we are committed to achieving a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time. And we’re not confident yet that we have achieved such a stance.”

Me: “Does the lack of confidence in achieving a sufficiently restrictive monetary policy leave open the possibility for future rate hikes?”

NotebookLM: “Yes, the lack of confidence in achieving a sufficiently restrictive monetary policy leaves open the possibility for future rate hikes.” {The rest of the response provided an incoherent timeline of Fed action}

Powell: “…the way we’re going to be going into these future meetings is to be just determining the extent of any additional further policy tightening that may be appropriate to return inflation to 2 percent over time” (Powell later reemphasized “it’s fair to say that’s the question we’re asking is, should we hike more”)

Me: This statement suggests that the Federal Reserve has a bias toward hiking rates again. What do you think? Explain your reasoning.

NotebookLM: “Yes, Powell’s statement suggests that the Federal Reserve has a bias toward hiking rates again...However, it is important to note that Powell also said that the Fed will “be humble” in its approach to raising rates, and that it will “listen carefully” to the data. This suggests that the Fed is not committed to a specific path for rate hikes, and that it will be willing to adjust its plans if necessary.” {Rest of answer repeated incoherent timeline even after I asked for a different explanation}

Powell: “the Committee is not thinking about rate cuts right now at all. We’re not talking about rate cuts, we’re still very focused on the first question, which is; have we achieved a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time, sustainably? That is the question we’re focusing on. The next question, as you know, will be for how long will we remain restrictive?”

Me: “How would you assess the odds of a rate cut anytime soon based on this comment and the rest of the transcript?”

NotebookLM: “The odds of a rate cut in the near future are low.

• Powell said that the Committee is not thinking about rate cuts right now at all.
• The Committee is focused on bringing inflation down to 2 percent sustainably.
• The Committee will consider a rate cut if inflation comes down and remains low for an extended period of time.

However, it is important to note that the Committee is also considering other factors, such as the strength of the economy and the labor market. If the economy slows down or the labor market weakens, the Committee may be more likely to consider a rate cut.”

I selected quotes that I thought were most likely to produce some insight into the market’s excitement over the prospects for monetary policy. So just to be thorough, I asked NotebookLM one last question: “Is there anything in this transcript that even hints at the possibility for easier monetary policy in the near future? What about prospects for an end to rate hikes? Explain your reasoning only using content from this transcript.”

NotebookLM concluded: “There is no indication in this transcript that the Fed is considering easier monetary policy or an end to rate hikes.” Its explanation was a repeat response to my previous question.

The Persistent Longing for Easier Monetary Policy

With just two months left in the year and earnings season nearing an end, eyes and prognostications turn to 2024. Year-to-date performance remains positive but the market’s three most dangerous months of the year stained market sentiment. Thus, the persistent longing for easier monetary policy is taking on a new urgency. A recent example came from Goldman Sachs (GS) in predicting a strong year for IPOs in 2024. The main reason for the optimism? Rate cuts! From the Yahoo Finance article “The ‘real IPO reopening’ is coming in 2024: Goldman Sachs“:

“Bruun’s case for IPOs to reemerge stems from a core stance repeated throughout Goldman’s 2024 outlook roundtable on Tuesday: The Federal Reserve will cut rates in 2024. And history says that’s usually an opportune time for the IPO market.

‘When expectation moves such that people are anticipating rate declines and are starting to see rates come down, that’s usually when IPOs open up,’ Bruun said.”

This kind of persistent longing for easier monetary policy is likely to pervade financial markets as the assumption of an end to rate hikes takes deeper root in market sentiment and psychology. If rate hikes have ended then, logically, rate cuts must be imminent.

Still, the Fed will also persist in doing what it can to prevent the market from getting ahead of the Fed’s desire to keep driving inflation to its 2% target. I fully expect Fed jawboning in coming weeks and months to do its best to work against the notion that easier monetary policy is on its way soon. Currently, Fed fund futures do not anticipate any more rate hikes, and the first rate cut comes in June. Both projections are the exact same as they were before the November 1st meeting. Thus this lack of change still has me scratching my head about a renewed excitement over the prospects for monetary policy. From the CME FedWatchTool (the blue boxes indicate the market’s projection for the most likely target for the Fed’s interest rate range the given meeting date in the first column):

The S&P 500

Finally, here is a close-up of the daily trading action in the S&P for perspective on the scale of the market’s recent excitement. Market breadth over this time period went parabolic. (image from TradingView.com)

The post Why the Excitement? A Q&A on Monetary Policy with Generative AI appeared first on Inflation Watch.

Valetta declared “recent data suggest that inflation may have peaked.” The latest inflation projection shows a gradual decline toward the Fed’s 2% average goal around 2025 or 2026. Valetta cautions that “repeated upside surprises” to inflation mean that “the risks to this forecast [are] weighted to the upside.” In other words, we should expect the Federal Reserve to keep its interest rate higher for longer in order to ensure inflation’s glide path stays pointed downward. The graph below shows the recent peak and successive higher forecasts for inflation since March.

After on-going upside revisions, PCE core price inflation is now expected to approach the 2% target somewhere around 2025. (Source: Federal Reserve Bank of San Francisco)

The cost of peaking inflation is slower growth. Valetta expects “growth to remain well below trend this year and next year before converging back to trend in 2025.” Conveniently, that return to trend occurs just as inflation returns to the Fed’s target. Most importantly, Valetta points to a mere one percentage point increase in unemployment “through 2024.” This expectation means that the onset of a recession next year will create a mild economic slowdown. Today’s unemployment rate is still near the historic low of 3.5%. Unemployment below 5% is surprisingly low for a recessionary environment. The high job vacancy rate softens the economic blow of slowing growth as there is plenty of room to cool off labor demand without disrupting the labor market.

Valetta acknowledged that the inversion of the yield curve suggests that odds are high for a recession: “such yield curve inversions have proven historically to be reliable predictors of recessions over the subsequent 12 months. After some divergence earlier this year, two leading measures of the yield spread have now both become inverted.” However, Valetta does not want readers to decide that a recession is a foregone conclusion: “their predictions come with substantial statistical uncertainty, however, and are not definitive indications that a recession is looming.”

Inverted yield curves have preceded recessions since the late 1980s. (Source: Federal Reserve Bank of San Francisco)

The Fed’s success in fighting inflation has come from a “proxy funds rate” that is much higher than the effective funds rate. According to the SF Fed, “this measure uses public and private borrowing rates and spreads to infer the broader stance of monetary policy.” The gap between the proxy and effective rate is higher than ever. No wonder Fed Chair Jerome Powell can so comfortably reiterate that the Fed can now slow the pace of rate hikes.

With peak inflation finally here, traders and investors should focus on how long the Fed intends to keep a restrictive stance on monetary policy. Given the extended period over which the Fed expects above target inflation, monetary policy should remain restrictive for longer than the market currently expects. In turn, the implication for the stock market of restrictive policy and below trend growth means valuations must come down further and cap upside in market returns for 2023 and perhaps 2024. Time will tell of course.

The S&P 500 (SPY) is out of bear market territory and now trying to fight its way through restrictive monetary policy.

Be careful out there!

The post The Fed Plants A Flag On Peak Inflation and An Economic Soft Landing appeared first on Inflation Watch.

The S&P 500 (SPY) rallied enough to punch through two important resistance levels. The cumulative losses from Jackson Hole are now almost reversed. (Source: TradingView.com)

If not for the stock market’s reaction, I would have interpreted Powell’s speech to land somewhere between hawkish as ever and no new information. In fact, there were several key points from the speech which should have told the market the Fed is as serious as ever about sustaining an extended fight against inflation (the following are direct quotes unless otherwise indicated; particularly important quotes in bold):

• It will take substantially more evidence to give comfort that inflation is actually declining. By any standard, inflation remains much too high.
• So when will inflation come down? I could answer this question by pointing to the inflation forecasts of private-sector forecasters or of FOMC participant…But forecasts have been predicting just such…a decline for more than a year, while inflation has moved stubbornly sideways.
• It seems to me likely that the ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting and Summary of Economic Projections. (a reiteration from the November monetary policy meeting)
• Restoring [supply and demand] balance is likely to require a sustained period of below-trend growth. (another reiteration)
• Despite the tighter policy and slower growth over the past year, we have not seen clear progress on slowing inflation. 
• It is far too early to declare goods inflation vanquished, but if current trends continue, goods prices should begin to exert downward pressure on overall inflation in coming months. (the stock market must have focused on this claim)
• As long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year. Indeed, a decline in this inflation underlies most forecasts of declining inflation. (in other words, this claim is old news)
• We can see that a significant and persistent labor supply shortfall opened up during the pandemic—a shortfall that appears unlikely to fully close anytime soon. (the stock market clearly did not hear this)
• The labor market, which is especially important for inflation in core services ex housing, shows only tentative signs of rebalancing, and wage growth remains well above levels that would be consistent with 2 percent inflation over time. (in other words the job market is at risk of sustaining high rates of inflation)
• Despite some promising developments, we have a long way to go in restoring price stability.
• It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting. (this is another reiteration, but the stock market seemed to treat this as welcome new news)

If the Fed Fund futures market reversed course and priced in lower peak rates, the stock market’s sudden burst of enthusiasm could have made more sense. However, futures speculators just shifted out the peak 5.00%-5.25% range by one meeting, from March, 2023 to May, 2023. The market did move up the schedule for the first rate cut and ended the year at 25 basis points lower. However, note well that during the Q&A Powell reiterated a warning about the market’s expectations for quick rate cuts: “Cutting rates is not something we want to do soon. That is why we’re slowing down.”

Fed Fund futures market peaked rates at the March, 2023 meeting ahead of Powell’s speech (source: CME FedWatch tool)

Fed Fund futures market peaked rates at the May, 2023 meeting after Powell’s speech and moved the first rate cut up by 5 months (source: CME FedWatch tool)

The day’s rally in the stock market is one of those many times to ignore contrary fundamental assessments and pay attention to what the market thinks. If buyers follow through with the 200DMA breakout on the S&P 500, I will assume seasonal tailwinds are in full flight. Absent any shocks, the market could then rally all the way into the Fed’s December 14th pronouncement on monetary policy. That event will give Powell a fresh chance to redirect financial markets if financial conditions loosen up too much by then. Maybe Powell will have to reiterate how the Fed will “keep at it” instead of “staying the course.”

The Q&A of the Brookings Institution session mainly reiterated points from the speech. There were two points that stirred my interest for future reference.

First of all, Powell actually admitted that the housing market was in a bubble. The conditions he described were easily observable at the time: “coming out of the pandemic, rates were very low, people wanted to buy houses, get out of the cities and move to the suburbs. You had a housing bubble. Had prices going up that were very unsustainable levels, and overheating…” However, of course, the Fed did not dare say the “B” word in the middle of the mania. Powell did not offer any thought on whether the bubble could have been moderated by hiking rates sooner…or at least jawbone about the bubble.

Secondly, Powell mentioned one regret from the 2020 policy framework reset that he mentioned almost as a footnote. Powell indicated that he would not repeat the mistake of relying on a long history of low inflation as a basis for making policy. At the reset, Powell communicated that the Fed would not “lift off” (start hiking rates) until it “saw both maximum employment and price stability.” The stock market soared on this news as it correctly interpreted the change as a Fed more tolerant of a higher range in inflation. Powell admitted that commitment “made us under-estimate tail risk.”

I soundly criticized this pronouncement at 2020’s Jackson Hole. While Powell insisted this mistake has nothing to do with today’s inflation, I continue to insist that this commitment made the Fed slow to respond to rising and then realized inflation risks. Members of the Fed have also dismissed the notion that starting rate hikes a little earlier would have made a material difference in the inflation landscape. We will never know the counterfactual of course. Still, I feel somewhat vindicated that the Fed has taken note of its policy mistake (and prior deflationary bias) and learned some lessons.

Be careful out there!

Appendix: Notes from the Q&A session

Wage increases are going to be a core part of the inflation story going forward.

The labor market has a real supply imbalance

For most workers, wage increases are being eaten up by inflation. Need price stability to get real wage increases.

We assumed that the natural rate of unemployment had gone higher during the pandemic. It’s very hard to pin down where it is when there is a massive disruption.

Used to be able to look through supply shocks. But if we have repeated shocks, it changes things. What are the implications if true? Very hard to know the answers. We tend to think things will return to where they were naturally, but that’s not happening.

Need to be humble and skeptical about inflation forecasts for some time, calls for a risk management framework. If you are waiting for actual evidence for inflation coming down, it is possible to over-tighten. Slowing down is a good way of balancing the risks.

Very few professional forecasters have gotten inflation right.

There isn’t any one summary statistic to determine when policy is sufficiently restrictive. We monitor the tightening of financial conditions (which happens based on expectations). We also look at the effect of these conditions on the economy. Look at the entire rate curve. For significantly positive real rates along the entire curve. Forward inflation expectations reflect confidence in the Fed getting inflation down to 2%. Look at exchange rates, asset prices. Put some weight on these things.

How do you know when you can stop shrinking the balance sheet? This has already been described in a document. We’re in an ample reserves regime. General changes will not impact the funds rate. Will allow reserves to decline until somewhat above where we think is scarcity. Hold the balance sheet constant….. The demand for reserves is not stable. It’s a public benefit to have plenty of liquidity.

Question: August, 2020 announced new flexible inflation targeting framework. Anything in that we should be rethinking. Answer: We will do another review in 2026 or 2026. We implemented through guidance of various kinds. Put in strong guidance because there were a lot doubters that we could ever achieve 2%. Neither did we know. One piece of guidance we wouldn’t do again (it doesn’t have anything to do with the inflation we are currently seeing): we wouldn’t lift off until see saw both maximum employment and price stability. It made us under-estimate tail risk. Remember 25 years of low inflation, inflation just didn’t seem likely.

Cutting rates is not something we want to do soon. That is why we’re slowing down.

It’s not reasonable to expect we get back to the labor force participation in 2020 before the pandemic. But I wouldn’t rule it out. It’s been disappoint and surprising how little we’ve gained back.

We have to assume that for now most of the labor force balancing has to come on the demand side. By slowing job growth, not putting people out of work.

At what point do people ask for more wages because they aren’t keeping up with inflation. Don’t know when that happens, but if it does, you’re in trouble. Labor shortage is not going away anytime soon.

Coming out of the pandemic, rates were very low, people wanted to buy houses, get out of the cities and move to the suburbs, You had a housing bubble. Had prices going up that were very unsustainable levels, and overheating, now the housing market is coming out the other side of that. We have a built-up country, we have zoning, it’s hard to get homes built to meet demand

Full disclosure: long SPY call spread

The post Stock Market Loves Powell Moving from “Keep At It” to “Stay the Course” On Fighting Inflation appeared first on Inflation Watch.

The current and projected jumps in labor costs are dramatic:

“…wage income for urban households rose 13% year-on-year in the first half, and average monthly income for migrant workers rose 14.9%, according to data from China’s National Bureau of Statistics. A labor ministry survey of 91 cities in the first quarter showed demand for workers outstripping supply by a record amount, pointing to low unemployment…

…At current rates, China’s private-sector manufacturing wages will double from their 2011 levels by 2015, and triple by 2017, eroding competitiveness and denting the exports that have played a key part in China’s early growth.”

These wage hikes are coming off low levels. For example, as of February of this year, Hon Hai Precision Industry Co, the company that manufactures Apple (AAPL) iPads, reported a 10% increase in base salary for its factory workers to 2,200 yuan ($345) per month.

Moreover, the supply of new, young workers will decrease thanks to China’s one-child policy:

“In 2005, there were 120.7 million Chinese people aged 15-19, according to United Nations estimates. By 2010, that had fallen to 105.3 million, and by 2015 it is expected to dip to 94.9 million.”

Finally the government is forcing the minimum wage and benefits higher:

“China is committed to sharply raising minimum wages, which puts pressure on employers to raise salaries for higher skilled workers. Beijing also has increased requirements for severance payments, which discourages layoffs unless business drops severely.”

It will be interesting to watch what happens to China’s economy as its manufacturing competitiveness declines slowly but surely with the increase in wages.

The post Wages on the rise in China appeared first on Inflation Watch.

“Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent.”

This is a sobering statistic that has potentially dire implications for the economy in general. Compare this situation to that in China where an on-going study in the New York Times concludes that China’s government has propped up its banks and large corporations at the expense of Chinese workers (see “As Its Economy Sprints Ahead, China’s People Are Left Behind.”):

“Under an economic system that favors state-run banks and companies over wage earners, the government keeps the interest rate on savings accounts so artificially low that it cannot keep pace with China’s rising inflation. At the same time, other factors in which the government plays a role — a weak social safety net, depressed wages and soaring home prices — create a hoarding impulse that compels many people to keep saving anyway, against an uncertain future.

Indeed, economists say this nation’s decade of remarkable economic growth, led by exports and government investment in big projects like China’s high-speed rail network, has to a great extent been underwritten by the household savings — not the spending — of the country’s 1.3 billion people.

This system, which some experts refer to as state capitalism, depends on the transfer of wealth from Chinese households to state-run banks, government-backed corporations and the affluent few who are well enough connected to benefit from the arrangement.”

Neither system, in the U.S. or China, appear stable to me. With China dependent on the income (or rising debt) of U.S. workers to keep its exports alive, these systems of increasing inequity actually start to look increasingly unstable. I will be monitoring these processes even more closely going forward. They are certainly deflationary, not inflationary.

The post U.S. workers missing out on the “reflation celebration” appeared first on Inflation Watch.

If negotiation go poorly, the actors will be left with zero pay. Hopefully, they will still get a cut of the treasure trove that awaits in syndication. NPR states that “…one analyst noted that ending the show would make it worth even more in syndication — perhaps $1.5 million for each of the show’s 506 episodes, which would bring in something like $750 million.” This means the studio actually has a large incentive to end the series rather than continue to pay high production costs to keep the show going.

For more, see or listen to “Do Rising Costs Have ‘The Simpsons’ On The Ropes?“

The post Production costs may have the last laugh on The Simpsons appeared first on Inflation Watch.

This weekend, I noted two state-based stories on executive pay that demonstrated how dramatic a turn-around has occurred in the pay for specific executives.

In “Lucrative paydays for corporate chiefs“, the Atlanta-Journal Constitution reports:

“Here’s one measure of just how good it was: $232.9 million.

That’s the total compensation that the chief executives at Georgia’s 25 most-valuable public companies took home last year, according to The Atlanta Journal-Constitution’s review of the annual disclosures required by the Securities and Exchange Commission…

Here’s another measure of just how lucrative 2010 was: 29 percent. That’s the average pay raise the 25 executives saw last year.”

In “Arizona CEO’s median compensation surged 48% in 2010“, The Arizona Republic reports:

“Sparked by rising profits and rebounding stock prices, the median compensation for chief executive officers and chairmen at Arizona-based public companies surged 48 percent in 2010, hitting a statewide record of $1.54 million.

Plus, hefty pay packages were shared more broadly by other top officials at 43 corporations based in the state. Some 74 senior executives below the CEO level earned at least $750,000, up from 63 who earned that much the year before.”

In both cases, compensation swelled partially thanks to a strong rebound in the stock market, meaning that corporate executives have greatly benefited from the reflation generated by economic stimulus and/or monetary easing. As I have mentioned in previous posts, strong corporate profits have supported all forms of equity-based wealth and effectively beat back the ghosts of deflation in 2010.

Of course, the huge irony is that poor employment reports and stagnating personal income data tell a different story. For example, after Friday’s awful jobs report and the on-going dire news coming from the housing market, you would be excused for assuming the entire country had dipped back into a poverty-stricken recession. Such is definitely not the case for the big winners of 2010.

The post Reflation celebration for corporate executives in Arizona and Georgia appeared first on Inflation Watch.