– by a New Deal Democrat
As I wrote on Saturday, several matching indicators have stabilized over the past few months (eg Redbook user sales, which were up roughly 5% year-over-year for 8 weeks; and payroll tax withholding, which was up just 1.2% on y/y for the last 4 months of 2022, but was up 4.7% y/y for the first 9 weeks of this year). This has led to heightened speculation that the US will avoid an economic downturn and perhaps even avoid a slowdown altogether.
But unless the Federal Reserve changes its view, I have a hard time seeing that happening.
First, Fed Chairman Jerome Powell, as well as other board members, expressed concern about the continued elevated level of inflation in their favorite gauge, the “sticky” price index for core PCE. Here’s the long-term historical view of that compared to the Fed rate:
And here’s a close-up after the end of the pandemic recession:
For most of the past 60+ years, the Fed funds rate has been higher than core PCE inflation. While this has not been the case for most of the past 15 years, it is certainly the case that the 5%+ gap in 2021 was the largest by which core PCE inflation exceeded the Fed rate. Given historical comparisons, the Fed probably thinks it needs to raise at least another 0.50% so that the Fed funds rate is at least equal to the rate of inflation.
And as I’ve noted several times before, this is the steepest rate at which the Fed has raised interest rates since 1982:
Only in 1974, 1980, and 1981 did the Federal Reserve raise rates faster. Because it takes time for the effects of Fed rate hikes to ripple through the economic system (for example, as I recently pointed out, housing starts are less than 1% below their all-time high set in October) , the downward pressure on the economy from these rate hikes is far from abating.
In addition, some members of the Federal Reserve have been clear they want to see a sharp slowdown in wage growth, which as of January had eased from its peak in 2021 of 7.0% but was still at 5.1% annually. base, extremely strong percentage of earnings compared to the last 40+ years:
To do this, they would have to introduce a game of ‘reverse musical chairs’ whereby the lowest paying employers at any given time find themselves unable to fill positions, resulting in competition to escalate the wages on offer, so that for don’t be the miserable loser.
And that means a reduction in the number of vacancies compared to actual hires:
the last figure we’ll know in the January JOLTS report on Wednesday.
Another way of looking at the same thing is that the sales vs. employment trend line, in which the former completely outperformed the latter after the pandemic stimulus rounds:
must return to equilibrium. Unless there is a renewed surge in employment growth (*extremely* unlikely), this means a decline in real sales. And in the past, a decline in real consumption *always* meant a recession:
