The Federal Reserve (Fed) takes the exit ramp to lower rates, but was deliberately ambiguous in its meeting so as not to reveal whether it will cut rates once or twice. But in the ‘dot plot’, the institution’s roadmap on rates, the members of the Federal Open Market Committee (FOMC) opted for one. The market and analysts continue to bet on two. The labor market continues to hold the key to how many declines there will be this year.
The biggest rate hike in forty years has collided with the toughest labor market in US history. Since the pandemic, economies have begun to function strangely, surprising economists and analysts. Part of the mystery is found in the labor market, with a lack of constant labor and a pressing need to increase salaries, which has ended up underpinning inflationary dynamics.
“The evolution of labor markets after the pandemic resembles wartime conditions, with large increases in the ratio of vacancies to unemployment,” says Adam Slater, chief economist at Oxford Economics. But for some analysts The hot job market phase in the US is very close to ending. “The current strength of labor demand is unclear, as nonfarm payrolls contrast with the initial and continued increase in jobless claims in recent weeks,” says Goldman Sachs chief economist Jan Hatzius.
For Goldman, the labor market has entered a clear inflection point. And this statement, at this moment, is saying a lot. For a long time, the strength of employment has upset the Fed. It did not fully understand how the economy continued to create jobs with the rate hike it had implemented. Powell called it a miracle.
“Ultimately, the main driver of labor demand is economic activity, and GDP growth has slowed significantly,” says Hatzius. The US economy slowed considerably in the first quarter of the year. GDP went from growing 3.4% at the end of the year to 1.3% in the first quarter of the year, in a clear sign of exhaustion. Goldman believes the economic outlook leaves room for two cuts, one in September and another in December.
The problem is that much of the labor market data still does not favor the start of the cuts. “It is important to look at not just one data point, but the trend and the three- and six-month moving averages of new jobs rose again in May. This will worry the Fed as an overly tight labor market puts pressure on wages and therefore also on prices,” emphasizes Felix Schmidt, economist at Berenberg.
The evolution of salaries does not help either. Average hourly earnings growth remained at 4% year over year, and the 0.4% monthly increase in May was significantly larger than the 0.2% increase in April. “”This is good news for consumers, but bad news for the Fed,” says the analyst and recalls that employment continued to show an upward trend in several industries, led by health care, public employment and restaurants.
The economist’s theory is that wage increases respond to lagged movements in response to the inflationary impact, to recover purchasing power. “Authorities risk being overly cautious by focusing too much on lagging wage growth,” he says.
But the labor market It works as a lagging indicator when it comes to gauging inflation. “Central banks have put a lot of emphasis on this in recent months, fearing a possible impact of wage increases on inflation, but there is considerable evidence to suggest that their focus on wage growth may be overstated,” he points out from Oxford.
In this monetary cycle, it has been common for market expectations of rate cuts to not match the Fed’s plans or for macroeconomic data to be mixed and not help to decipher the equation. Either because there is excess zeal on the part of the central bank or because the hard tones of the bankers are not given credence.
The federal funds rate has remained at 5.25-5.5% since July. When it was confirmed that this would be the ceiling of interest rates, the market anticipated discounting cuts and assumed that the decline would be as rapid and pronounced as the rise. But that excess of optimism that came to budget for seven drops of 25 basis points has had to back down.
The euphoria has subsided with the message that the last stretch of inflation would be persistent and, after a long digestion, market expectations have moderated considerably. Now the gap between investors and the central bank is much smaller, although it still exists, both sides are more aligned.
In moments of excessive optimism, time has somehow ended up proving Jerome Powell right, since, to date, the FOMC has had no compelling reasons to carry out such easing. That is to say, unemployment has not risen to dangerous levels, nor has there been a recession. Prospects for rate cuts were exaggerated.
However, the tables have turned and it seems that now it is the Fed who is exaggerating. The organization only fully discounts a cut of 25 basis points, but the ‘dot plot’ has nuances. The document did not leave the circle closed, since it reflected a cut and a quarter cut, instead of opting directly for one or two, it remained between two waters. In fact, some analysts criticized the Fed for ambiguity, since the dot plot is used for the organization to update its economic and monetary policy forecasts quarterly (the ‘dot plot’), but, this last time, it did not serve to clarify doubts or tipping the balance.
The markets, which have made their own calculations, also taking into account the macroeconomic data, are not buying the harsh tone of Powell and the rest of the officials, who see things as over the top. The investors who They predict two declines for this year, they hold 45.7% of the positions and are the majority group, according to CME’s FedWatch tool. The remaining percentage is divided into four other groups with different bets, but the consensus is 50 points of flexibility.
On the other hand, US bond yields are correcting since the last central bank meeting and have recently hit three-month lows. That is, the tendency is to subtract restriction from the horizon. In any case, the debt has not declared victory either, but it already reflects at least one cut, with half a year left until there are more. The six-month title yields 5.15%. Meanwhile, returns at longer maturities, between two and ten years, are cooling considerably. This movement does not match what the central bank has budgeted, so fixed income does not fully trust the more hawkish Fed.
