Fed: Labor and inflation/interest emphasis from Powell

“Some of the participation gap reflects workers still out of the workforce because they have contracted Covid-19 or continue to experience persistent symptoms from previous COVID infections. But recent research by Fed economists shows that the participation gap is now mostly due to over-retirements—more than would be expected simply from the aging of the population. These surplus pensions can now account for more than 2 million of the 3 1/2 million shortfalls in the workforce. Data so far do not indicate that excess pensions are likely to ease as retirees return to the workforce. Older workers are still retiring at higher rates, and retirees do not seem to be returning to the workforce in sufficient numbers to significantly reduce the overall number of over-retired.”

Powell also said the combination of lower net migration and an increase in deaths during the pandemic was likely together responsible for about 1.5 million missing workers. Labor force participation was 62.2% in October, a full point below 63.4% in February 2020. Economists expect the November data to be announced by the Labor Department on Friday will increase to 62.3%.

Lack of Labor Force Participation Continues… Participation rate still well below pre-pandemic levels… Source: US Department of Labor, Bloomberg

If we look at the highlights of Powell's statements;

 In his speech, Powell stressed that the Fed cannot rely on an increase in labor supply to ease wage and price pressures in the near term and should instead continue to raise rates to slow the economy and drive down labor demand.

While the October inflation data received so far presents a pleasant surprise to the downside, these are single-month data following the upside surprises of the previous two months. As Figure 1 clearly shows, months of data decline were often followed by renewed increases.

It seems to me that the final level of rates will need to be slightly higher than was thought during the September meeting and the Summary of Economic Projections.

As new rent inflation continues to decline, we expect housing services inflation to begin to decline next year.

It would be beneficial to slow down our rate of increase in interest rates as we approach the level of restraint sufficient to reduce inflation. The time to soften the rate of increase may come soon after the December meeting.

We will stay on course until the job is done.

Figure 1: Total and core PCE inflation… October data are estimates of October data from consumer price index and producer price index, PCE is personal consumption expenditures… Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve

According to Powell, significantly more evidence will be needed to provide comfort that inflation has indeed fallen. By any standard, inflation is still very high. Food and energy prices are very important to household budgets. But core inflation often gives a more accurate indication of where overall inflation is headed. The path to inflation is rather uncertain. Accordingly, interest rates need to be raised to a sufficiently restrictive level to return inflation to 2%. Here, too, there is a serious uncertainty about which ratio will be sufficient. This will mean continued increases.

Fed tightens policy stance to slow aggregate demand growth. The slowdown in demand growth will allow supply to catch up with demand and restore equilibrium that will ensure stable prices over time. Restoring this balance will likely require a period of sustained below-trend growth. Last year, the continued reopening of the economy drove real gross domestic product (GDP) growth very strongly to 5.7%. This year, GDP has been roughly stable for the first three quarters, and indicators point to moderate growth this quarter, indicating a very moderate growth overall for the year. Various factors contributed to this slowing growth, including the waning effects of reopening and pandemic financial support, the global consequences of Russia's war against Ukraine, and policy actions that tightened financial conditions and impacted economic activity, particularly in interest-sensitive sectors. We can say that demand growth has slowed down and it is thought that this growth should continue at a slower pace.

Despite tighter policy and slower growth last year, there has been no clear progress in slowing inflation, according to Powell. To assess what it takes to drive inflation down, they break core inflation into three categories of components: core goods inflation, housing services inflation, and non-housing core services inflation.

Figure 2: Components of core PCE inflation… October data estimates based on October data from consumer price index and producer price index… Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve

Fed officials are rapidly raising interest rates this year in an effort to push inflation down from four-year highs. According to futures contracts, the central bank's reference federal funds rate is currently just under 4%, and investors generally expect it to peak around 5% next year. Powell did not add a new view on the assumptions. In this regard, employment data on Friday will be critical among the indicators discussed. It is important to emphasize that an interest rate decision cannot be made by looking at the soft data of inflation for a single period. The Fed is putting some brakes on rate hikes, but we also know that rates will be higher than they are today.

Kaynak: Tera Yatırım-Enver Erkan
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