On the afternoon of June 16th, Fed chair Jerome Powell will announce the decisions from the Federal Open Market Committee meeting this week. Nearly all market participants expect monetary policy to remain unchanged, along with the current bond-buying program. The market will continue to see zero interest rates with 120 billion in bond purchases each month for the time being.
Unemployment Impact on the Economy
The big questions economists are seeking answers to revolve around how the Federal Reserve plans to end the current QE environment. It seems likely the Fed will continue pointing to slack in the labor market, specifically the supply side as one of the reasons to maintain the current course. Demand for labor has been strong, but businesses still report difficulties in hiring employees. A few reasons being child care and high unemployment benefits that are two correlated with the pandemic. With kids not entirely back in school, parents may have been unable to seek employment despite a desire. Unemployment benefits from the pandemic have also been blamed for being too generous, thus causing workers to remain out of work.
While these are likely the reason some people remain out of the workforce, wages will continue to be the primary driver for employees. As the debate over the federal minimum wage rages in Washington, more and more examples of firms raising their minimum wage and being flooded with applications trend across the internet. With the unemployment rate above 6% and well above pre-pandemic levels, one of these forces of the market will cede, either firms will pay more for labor to not lose business or social issues will return to pre-pandemic norms and workers will be forced to return to the market. The timeline for this to play out may not be what the market expects, however.
Inflation Impact on the Fed
Institutional traders don’t expect the Federal Reserve to signal any tapering action until August or September of this year. The earlier this announcement is made, the larger the shock to stocks one would anticipate, primary growth stocks as higher interest rates lead to multiple compression at an uneven rate. Recent inflationary data could be the key driver to action from the Fed at this stage. The CPI data from last week showed a 5% increase over the past 12 months. Traders quickly reacted to this news as a change in CPI signals inflationary forces which in turn change the investing environment, Fed Chair Powell has said before they are comfortable with inflation running over 2% for a decent amount of time. The statement reads broad purposefully since the Fed will want to keep their options open if inflation suddenly starts running out of control.
One of the reasons the Fed may be accepting of the recent CPI data is that much of the reported inflation comes from a few areas hit by supply chain issues. The used car market has seen prices increase 21% in the last 12 months, while the energy index saw an increase of 28.5% over the past 12 months. These two areas may be dragging the yearly inflation data higher, the energy index remained relatively flat from April to May, while used cars continued to climb. This indicates other areas of the economy are starting to see increased prices, which aren’t necessarily a bad thing, as long as they don’t spin out of control. Depending on how one chooses to look at this, there is an argument to be made that since the inflation comes from two primary areas may subside as the supply chain issues are mitigated.
Alternatively, one may point out that with energy remaining relatively flat, the CPI as a whole still saw increased prices, signaling other areas are picking up steam.
This is exactly the debate the Federal Reserve will need to have over the coming days to determine their best course of action. Markets still anticipate 2023 before rate increases come, but that timeline has been moving earlier over the past 2-3 meetings. The language Jerome Powell uses to outline the Fed’s strategy as it relates to these inflationary pressures will be interesting and certainly move the markets.
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