To be honest, we’re getting pretty tired of dealing with market fireworks every time the Fed provides a hint of what they are going to do next. Traders are logically obsessed, but investors need not be dragged into this obsession. This week was a perfect example. The market twitched wildly to the perception of a more hawkish Fed, but from our perspective, the message from the Fed was clear and largely unchanged. There was really nothing new to see at this Fed meeting. Here’s our summary:
- Inflation comes down more slowly than it goes up
- If inflation is to come down, unemployment must go up
- Unemployment isn’t going up (yet), so rates must go higher
- The window to a soft landing is getting narrower; Recession risks continue to rise
The markets might twitch at every word the Fed says, but these bullet points are the guts of the message. We admit it’s getting to be an old story, but we continue to believe it could be a rough ride out of this inflation mess.
The table below is a summary of the individual estimates of the 19 Fed governors. The yellow shading is the December projection, the orange shading is the previous projection, released in September, so we can see the changes in their collective thinking over the last three months.
Here are the highlights:
- Unemployment Rate: What we notice is that even the long run unemployment projection is higher than today. The only conclusion you can draw is that unemployment must go up from here and rate pressure will continue until that happens.
- In case you don’t believe them, the Fed Funds rate projection (bottom) has gone from 4.6% in September to 5.1% in December.
- Although the CPI data this week implies inflation is moderating faster than expected. The Fed’s estimate of Core PCE inflation for the year is now projected at 3.5% versus 3.1% in September. Clearly, the Fed does not expect a ‘quick pivot’ back to lower rates. Markets are anticipating a quick pivot, but they should be careful what they wish for. A quick pivot implies that there has been some economic calamity to change the Fed’s course back to very low interest rates.
- Recession risks continue to rise as GDP projections for 2023 continue to deteriorate. The range of estimates has moved from -0.3% to 1.9%, to a range of -0.5% to 1.0%. The Fed’s optimism for a softish landing is being tested.
For us, the highlight of the presser was when Powell repeated his comments from his Nov. 30 presentation at the Brookings Institute that core service inflation was the key problem. Of course, the key input for core services is labor. If the labor market does not weaken, there is no solution of core services inflation.
We learned a long time ago not to fight the Fed and we are not going to start now. The longer the labor market stays tight, the longer the Fed will feel the need to raise rates. So don’t worry about the Fed, watch the economy, especially the labor market. That will tell you all you need to know. In the meantime, let the traders trade. We will stick to our long-term plan.
What We’re Reading
Core Inflation, CPI, Economic Growth, Federal Reserve, GDP, Inflation, Interest Rates, Jerome Powell, Palumbo Wealth Management, Recession, Unemployment