Economic power is forcing the Fed to become more aggressive

On Tuesday, we learned that U.S. employers had a record 11.5 million jobs in March. This is arguably the clearest sign that the economy is booming, as hiring workers is not cheap and most employers would only do so if they do not already have staff to monitor demand.

There are currently only 5.9 million unemployed. In other words, almost two jobs are created for one unemployed person. Non-compliance means that workers have a lot of options, which means they have a lot of influence to ask for a higher salary. Indeed, employers pay at a historic rate.

But growing demand, record new jobs and higher wages are bad?

The Federal Reserve and many in the economic profession do not speak so openly. But that is actually their message.

Game status: Demand for goods and services has far exceeded supply, 1 leading inflation to decades of high rates. This is partly due to the fact that higher wages mean higher costs for businesses, many of which have raised prices to maintain profitability. Ironically, these higher wages have helped strengthen the already strong finances of consumers, who are willing to pay and thus essentially allow companies to continue to raise prices.

It is important to add that this growing demand is underpinned by job creation (i.e., a phenomenon in which one goes from not earning anything to something). In fact, the U.S. has created an incredible 2.1 million jobs so far in 2022.

The Bureau of Labor Statistics has a metric called the Index of Total Weekly Payrolls, which is a product of jobs, wages and hours worked. It is a rough proxy for the total nominal labor consumption capacity. This indicator in April increased by 10% compared to the previous year and was above 9.5% since April 2021. Before the pandemic it was in trend around 5%.

This combination of job growth and wage growth has only exacerbated the problem of inflation.

Therefore, the best solution seems to be, at the moment, tightening monetary policy to make financial conditions a little more challenging, which should cause a cooling of demand, which in turn should alleviate some of these persistent inflationary pressures.

In other words, the Fed is working to take its feet off some good news coming from the economy because that good news is actually bad.2

The Fed is trying to reduce ‘excess demand’ ‘

In a widely expected move, the Fed on Wednesday raised short-term interest rates by 50 basis points to a range of 0.75% to 1.00%. This was the largest increase the central bank had made in a single announcement since May 2000.

Furthermore, Fed President Jerome Powell signaled the intention of the Federal Open Market Committee (i.e. the Fed’s monetary policy committee) to keep rising rates at an aggressive pace.

“Assuming economic and financial conditions develop in line with expectations, there is a broad sense in the Committee that an additional 50 basis points should be on the table at the next few meetings,” Powell said. “Our overarching focus is to use our tools to bring inflation back to our 2% target.”

To be clear, the Fed is not trying to force the economy into recession. Instead, it tries to make excess demand – which is reflected in having more jobs than unemployed – more in line with supply.

“There’s a lot of excess demand,” Powell said.

Fed Chairman Jerome Powell (Getty Images)

Fed Chairman Jerome Powell (Getty Images)

There are currently huge economic shocks, including excess consumer savings and growing capital orders, that should boost economic growth for months, if not years. And so there is room for the economy to let go of a certain pressure of demand without going into recession.

Here’s more from Powell’s press conference on Wednesday (with relevant links added):

It would be a far riskier situation if consumer and business finances are stretched with no excess demand. But that is not the case at the moment.

And so, while some economists say the risk of a recession is rising, most don’t see it as a baseline scenario for the near future.

Is that bad news for stocks? Not necessary.

When the Fed decides it’s time to cool the economy, it does so by trying to tighten financial conditions, which means funding costs are rising. Generally speaking, this means a combination of higher interest rates, lower market values, a stronger dollar and stricter lending standards.

Does that mean stocks are doomed to fall?

Well, the Fed hawk is definitely a risk for stocks. But nothing is certain when it comes to predicting the appearance of stock prices.

First of all, history says that stocks usually rise when the Fed tightens monetary policy. It makes sense when you remember that the Fed tightens monetary policy when it believes the economy has some momentum.

However, the prospects for higher interest rates are definitely worrying. Most stock experts, such as billionaire Warren Buffett, generally agree that higher interest rates are bearish for estimates, such as the P / E ratio for the next 12 months (NTM).

But the key word is “valuation,” not stocks. Stock prices don’t have to fall to lower values ​​as long as earnings expectations rise. And expectations for earnings grew. And indeed, values ​​are falling for months.

The diagram below by Jonathan Golub from Credit Suisse shows this dynamic. As you can see, the NTM P / E has been trending lower than the end of 2020. However, stock prices have been mostly rising during that period. Even with the recent market correction, the S&P 500 is higher today than it was when values ​​began to fall. Why? Because, earnings in the next 12 months essentially just grew.

To be clear, there is no guarantee that stocks will not continue to fall from their highest values ​​in January. And there is certainly a possibility that future earnings growth could become negative if the business environment deteriorates.

But for now, earnings prospects remain highly resilient, and this could provide some support for stock prices, which are currently experiencing a fairly typical sell-off.3

More from TKer:

Mirror 🪞

📉📈📉📈 Stocks are coming to an end: The S&P 500 fell just 0.20% to round off an incredibly changeable week. On Wednesday, S&P rose 2.99%, the biggest one-day index growth since May 18, 2020. It fell 3.56% the next day, the second worst day of the index of the year.

(Source: <a href=@JillMislinski) “data-src =” https://s.yimg.com/ny/api/res/1.2/w3reUeu62hPgXJgI6dYVSw–/YXBwaWQ9aGlnaGxhbmRlcjt3PTk2MA–/https://substackcdn.com/image,foc/ , q_auto: good, fl_progressive: steep / https% 3A% 2F% 2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com% 2Fpublic% 2Fimages% 2Ff5544db4-66d8-4202-4504362 >

S&P is currently down 14.4% from its January 4 high of 4,818. For more information on market volatility, read on this one, this one and this one.

💼 Job creation: U.S. employers added 428,000 healthy jobs in April, according to BLS data released Friday. That was significantly more than the 380,000 jobs economists expected. The unemployment rate was 3.6%. Read more about the situation on the labor market this one.

📊 The growth of service activity is cooling: According to data collected by the Institute for Supply Management, activities in the services sector slowed down in April. From Anthony Nieves, Chairman of the ISM Services Business Research Committee: “The service sector continues to grow, expanding over all but two of the last 147 months. There was a withdrawal of the composite index, mostly due to limited labor and slowing the growth of new orders. Business activity remains strong; however, high inflation, capacity constraints and logistical challenges are obstacles, and the war between Russia and Ukraine continues to affect material costs, most notably fuel and chemicals. ”

Up the road 🛣

There is currently no bigger story in the economy than the direction of inflation. Therefore, all eyes will be on the April Consumer Price Index (CPI) report, which will be released on Wednesday morning. Economists estimate that the CPI increased by 8.1% over the month compared to the previous year, which would be a slowdown compared to March of 8.5%. Excluding food and energy prices, the core CPI is estimated to have risen 6.1%, down 6.5% in March.

Check out the Transcript calendar below with some of the big names who released their quarterly financial results this week.

1. We will not go into all the nuances of the supply chain problem here (e.g. how the shortage of labor in the US, the blockades associated with COVID in China and the war in Ukraine are hampering production and trade). However, we know that problems in the supply chain still exist, which is reflected in the constantly slow delivery times of suppliers.

2. For those of you who are new to TKer, I wrote something about how good economic news was “bad” news. You can read more about it here, here, here and here.

3. Investing in stocks is not easy. This means you have to deal with high short-term volatility while waiting for those long-term gains. Everyone is welcome to try to determine the time of the market and sell and buy in an effort to minimize those short-term losses. But, of course, the risk is to miss those large clusters that occur during unstable periods, which can do irreversible damage to long-term yields. (Read more here, here and here.) Remember, there is a whole industry of professionals who aim to beat the market. There are few who can surpass the results in any year, and of the better ones, few are able to continue that effect from year to year.

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