Economy Slowing. Inflation? No!

Markets Run Ahead of Reality

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It was a winning week for equities and fixed income. The common factor behind the rally was the second signal in less than a week that the US economy is slowing. The employment report for April released on May 3 recorded job creation of only 175,000, far less than had been anticipated. The increase in the unemployment rate from 3.8% in March to 3.9% was accompanied by a slowing in the increase of average hourly earnings to 3.9% during the past twelve months.

The second indication of a slowing economy was a more updated statistic. It was the publication on Thursday of unemployment benefits for the week ended May 4 showing that initial jobless claims for benefits had risen by 22,000 for the week to a seasonally adjusted 231,000. This was the highest level since August 2023. Fewer increases in nonfarm payrolls, lower level of job openings, and an increase in jobless benefits, all suggest a slowing economy.

Markets interpreted the data as signs of slackening in a previously tight labor market. With them, hopes grew of the first reduction in interest rates taking place on June 12 at the end of a two-day Federal Open Market Committee meeting.

Any enthusiasm Federal Reserve Chairman Jerome Powell and his colleagues may have felt was dampened, however, by fresh news on the inflation front. They had already discovered that the pick up in inflation during the first two months of 2024 was not just a case of start-of-the-year quirks in data when all the major measures of inflation for March — including in the Personal Consumption Expenditure index, the Fed’s favorite — showed an upturn from prior months.

Then, the widely followed University of Michigan survey of consumer sentiment published yesterday showed a sharp fall in the index this month, with higher inflationary expectations being a key factor. Consumers’ expectation of inflation over the coming year jumped to 3.5%, above both the prior month as well as the anticipated figure, which were both 3.2%. Further, “long-run inflation expectations remain elevated relative to the 2.2-2.6% range seen in the two years pre-pandemic,” said Joanne Hsu, the survey director.

The latest development on the price front will likely not deter Fed officials from toeing the party line set by Powell’s statement at his press conference on May 1, viz., “I think it’s unlikely that the next policy rate move will be a hike.” With expectations of price increases already elevated, such a Fed stance of nonchalance on monetary policy, and the rally in equity prices this week, will do little to dampen inflation.

The Dow Jones Industrial Average enjoyed an eight-day winning streak through last night, and the yield on 10-year Treasurys fell from 4.5% to start the week to 4.45% Thursday night. Concerns about the implications of the University of Michigan survey was behind the Treasury yields’ rise yesterday but equities continued their victory march. “In the Powell Put we trust!” was the mantra for equities.

All of this brings us to the question that SriKonomics has posed before: Why would the Federal Reserve want investors to believe that there will not a rate increase when central bank officials have been repeatedly, and grossly, wrong on their inflation predictions? After all, they should know that comments suggesting no further tightening would push up equity valuations, making it that much more difficult for monetary policy to fulfill its primary objective.

The Powell Fed’s pro-inflationary policies cannot be explained by ignorance of economic theory. After all, voting officials are backed by a staff of experts in several related fields. But the frequent appearances of the officials on public media may provide a clue. They must be going beyond inflation-hit wage earners to enhance their marketability to potential future employers in the private sector. Boosting equity valuations, even at the cost of higher inflation, would be a winning strategy for job-seekers!

SriKonomics has a suggestion for when Powell starts his next post-FOMC press conference. He should not only provide his mandatory indication of concern over pain felt by low-income families from inflation, but also carry enough facial tissues to wipe tears and show that he really cares! Policy measures to actually bring down inflation can come later.

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

May 11, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities.  Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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