One of the most missed stories in the downward revision to payroll employment, regardless how big it ends up, it reinforces evident that productivity growth is improving and seems to be sustaining above pre-pandemic trend. That is really important for soft landing scenario. Former Fed Chair Alan Greenspan attempted to preemptively stop inflation in 1994-95. He doubled fed funds rate in a year. The economy stalled out in first half of 1995 and he held rates higher for longer except for a flinch an quarter point cut in July 1995.

Next Friday the employment report for July will be released and there is a very high probability that the unemployment rate triggers what is known as the “Sahm Rule,” a recession indicator named for @Claudia_Sahm.

She herself has warned that it might not be signaling what it did in the past, given the unique nature of the post pandemic economy. Rules, much like Olympic records, are meant to be broken. Much of the rise in unemployment that we have seen thus far in the Federal Reserve’s credit tightening cycle has been due to a rise in the number of people participating in the labor force and seeking work, as opposed to a surge in layoffs.

Still, not all is coming up roses. Those who have lost a job are finding it harder and taking more time to replace it, while the unemployment rate among new college grads has risen more rapidly than that for overall college grads. Unemployment claims have also moved up, exacerbated by Hurricane Beryl and its devastation in Texas the week of the survey for the July employment report.

Lots of back and forth on inflation. A lot can be true all at once. First, let’s back up and acknowledge that the CPI & wage measures are aggregate measures - they represent everyone but no one individual. Hence, the importance of having the break down that.. ..stats agencies, Federal Reserve system and independent groups doing by income strata.

Inflaion has cooled but the level of prices remains elevated & people feel as though they are losing ground. Low income hh struggling most.

🥶The ice is thinning…red flags are emerging for the US economy.

A 🧵”Sahm Rule” & how elusive soft landings truly can be. What is often touted as a victory, the 1994-95 tighten and easing cycle was more about luck than skill. The employment report showed we added 206K jobs after downward revisions to May. More than a third of those gains were in state and local hiring; gains were less broad based than I would like and we tend to get a lot of layoffs in June and July in the public sector, which makes for easy seasonal adjustment of the data.

Soft landing or not…many point to the 1994 hiking cycle, which culminated with a once unheard of .75% bump in the fed funds rate at one meeting as a model for soft landing.

I remember it differently. Former Chairman Greenspan was focused on checklist… …of things he believed caused inflation. They spanned unemployment to factory utilization. As we crossed those thresholds, he started to GRADUALLY raise rates. The gradualism was his thing.

Then the economy cratered. We had two months in a row of red ink in employment in 1995 & the Fed cut.

Real GDP revised down to 1.3% in 1Q from an initial report of 1.6%. The trade
deficit widened & shaved 0.9% from growth alone. Another 0.5% was lost to a drop in inventories; those losses should provide a tailwind for manufacturing. The largest downward revision was consumer spending. An acceleration in spending on services, where inflation remains hottest, was tempered by a ⬇️ in spending on goods. This echos challenges retailers cite. Big ticket durable goods, which require financing, contracts the most. Credit card usage flatline, as subprime & young borrowers hit limits.

More on the break between economic data & perceptions.

New Harris Guardian Poll reveals that majority of Americans believe we are in a recession. This despite other measures which show greater personal job security, with desire & confidence increasing in ability to switch jobs.

Here is the link to the poll results and story

theguardian.com/us-news/ng-int… I have written a lot about differences in perceptions vs aggregate data. They are odd but I do think it is importantly to acknowledge that this has been an extraordinary time. Problems that were simmering pre pandemic came to a boil with pandemic.

Ok. Sorry for confusion. Here is a corrected & hopefully more straight forward version.

The inflation data on CPI was a relief because it was not as bad as many feared after a hot read on the producer price index (PPI).

What matters is where inflation is & is not. Shelter costs moderated on a drop in hotel room rates. The shelter component is expected to roll over more “convincingly” for the Fed as we move into Spring and Summer. However, Fed is a bit worried that improvements in rents and owner’s equivalent rent might stall.

Data & perspective

Inflation peaked in June 2022

The deceleration we have seen since is the fastest in 50 years,
w/o brutal rise in unemployment.

The length of time that prices accelerated was short in historically but the first such acceleration in decades. Still painful.

Wages have outpaced inflation since mid 2023, but we need to do more than regain what was lost to inflation - consumers want to feel improvements in living standards above and beyond 2019 levels. Hard to do when costs of essential such as shelter and vehicle to get to jobs so high. Between 2019 & 2023, home prices up 50%, rents up 30% and wages up ~ 18%. Everything is no longer rising all at once but disinflation does not equate to price cuts across the board.

Low-wage workers who went from invisible to essential saw their wages leveled up, moved from the shadows into the sun, only to be burned by inflation.

Wealth increased at the fastest inflation-adjusted 3-year pace on record - ⬆️37% - from 2019 to 2022; the gains were across income strata. However, inequality worsened and the ranks of those in poverty increased.

Relativity mattes as does keeping up with the Joneses.

Momentum & heat

Real GDP rose at a 1.8% pace in the first quarter, a sharp slowdown from the 3.4% pace of the fourth quarter. Much of that slowdown could be attributed to a widening of the trade deficit, a DROP in federal spending and a further liquidation of inventories. The latter two will be reversed in the second quarter. Underlying demand remained solid. Consumer spending grew at a 2.5% pace with spending on services offsetting a drop on spending on big ticket goods that need be financed, notably vehicles. People are catching up on their medical care, having families and struggling with long COVID. Others are stepping out, traveling and reengaging with large in-person group events.

Big GDP and PCE data in week ahead:

We will get the first estimate of the GDP for the first quarter.

Growth could come in ~ 2.5%, with many bracing for an upside surprise given the @AtlantaFed GDP nowcast running at 2.9%:

-Consumers remained defiant, posting solid if not spectacular gains after accelerating in the second half of 2023.
-Business investment likely picked up, aided by investment in chip plants, new tech and intellectual property.
-Residential investment picked up after a soft fourth quarter, aided by temporary drop in mortgage rates. Single family home builders continue to move downscale to tap pent up millennial demand. Higher rates could crimp second quarter gains. Multifamily construction hit hardest.
-Inventories were rebuilt after drawdown in fourth quarter.
-Federal gov’t spending was constrained by the continuing resolution. State & local (lion’s share) held up better.
-BIGGEST NEGATIVE => Trade deficit widened as U.S. outperformed major trading partners. The PCE inflation index by our estimate is expected to rise less than the overall consensus due to weight for food.

Action is in the core and super core services.

-Core up 0.3% in Mar, same as Feb. That translates to a slight tick down on Y/Y to 2.7% but the 3M annualized accelerates a bit 6M cools slightly but still too hot.
-Super core 0.2% in Mar, same as Feb. That translates to 3.2% Y/Y from 3.3% last month. 3M annualized cools slightly along w/6M but both still too hot for Fed.

One of the difficult aspects of inflation has been the game of wack a mole.

Prices have generally trended down until recently.

Much of the improvement we have seen has been aided but not due entirely to a healing of supply chains that got scrambled in the wake… …of reopening. The Federal Reserve welcomed those shifts as they helped to take the steam off inflation in a fairly dramatic way in 2023.

Overall inflation measures slipped below the pace of wage increase and some started to regain purchasing power lost to inflation.

After reading a lot of “hot takes” on inflation, I realized a few things are worth underscoring.

A Top 10 List

1) The Fed made no commitment to cut rates at today’s meeting; they just didn’t change expectations that rate cuts are likely this year.

2) The median forecast is for three cuts BUT the number of people expecting to cut two or less rose. 3) The Fed is managing risks. It is balancing the risk of cutting rates prematurely and
triggering a more persistent bout of inflation against the risk of holding rates too high for too long and causing an unnecessary recession. Policy shifts take time to play out, and can be nonlinear in their impact.

4) @federalreserve Chair Powell said every meeting is live. Nothing is set in stone in terms of the course of policy.

Inflation, uncertainty and the Federal Reserve. I spend a lot of time looking at inflation both with my team, a diverse set of economists and anyone & everyone I talk to professionally & personally in every walk of life.

The data on the economy are but a flashlight on a path in what is becoming an increasingly dense forest. The pandemic shifted and accelerated cyclical and structural in nature. Those triggered a massive collision between demand and supply, which proved combustible.

One of the most interesting areas of inflation that illustrates the complexity of the forces at work, is the massive run-up in insurance costs.

Payroll employment came in at 275,000 jobs in February, after a downwardly revised 229,000 in January. The three-month and six-month moving averages moved up in recent months, after slowing during work stoppages due to strikes over the summer and into the early Fall of 2023. (E.g., The downward revisions to January did not shift the narrative that payroll employment looks like it is picking up again.) Gains were dominated by the big 3 - healthcare and social services, leisure & hospitality and state and local government hires, outside of education. All three have room to run. Healthcare and social services are chasing a moving target due to aging demographics and the drop in quit rates; more workers are utilizing their benefits than when churn was skyrocketing.

Big week for data: CPI and retail sales come out, while we get more Fed speakers talking about the outlook and the patience surrounding rate cuts.

The CPI is expected to further cool on the heels of lower prices at the gas pump and a moderation in food inflation. Dairy products actually dropped from a year ago last month. Milk prices are second to prices at the gas pump when it comes to shaping people’s inflation expectations. Overall inflation as measured by the CPI is expected to slip below 3% in January, its lowest annual pace since March 2021, which marked the onset of the pandemic-induced inflation, although the pace of inflation was still close to 2% than 3% back then.

Have two straight weeks of meetings with economist and policy experts across countries. Taking a breather after my first week of meetings. Here is some issues that bubbled to the top.

1) Is the US economy really as good as it appears - what can and can’t be trusted in our economic models?

Households debt: consumer’s demised has been greatly exaggerated. Be careful with extrapolating household debt & delinquency data. Record delinquencies every month for subprime vehicle borrowers last year did not equate to defaults or a vicious cycle for lenders and borrowers. Why? Most who went delinquent kept their jobs and were able to service debt and avoid a default, while access to credit for lowest credit score borrowers dried up.

Wealth effects in stock market are more disperse, with record 58% of households owning stock according to Federal Reserve in 2022 vs 53% in 2019.

However, much more housing market wealth has gone to baby boomers who are aging in place. That is a big issue for younger millennials who are now need help of parents to achieve home ownership more than previous generations.

Moral of story: We are not like to see the consumer collapse short of a jump in unemployment. 2) How well are margins in private companies holding up relative to public companies? How big of a paywall or cliff will we hit in private sector debt as it resets at higher rates than earlier in the cycle. Not a lot of transparency here. Public corporate debt has longer maturities and not facing as many hurdles.

Today’s PCE data confirmed the good news we saw in yesterday’s GDP report on consumer spending and inflation.

Core PCE (excluding food and energy) and is the best predictor of inflation rose 0.2% but dipped to 2.9% from a year ago in December. That is below the threshold that the Fed said they needed to see consistently to cut rates. The three and six-month annualized pace hit 2% in the second half of 2024. Gains in services inflation were tempered by another decline in goods inflation. The Fed is weighing whether the good news on goods inflation can continue. Core services inflation ticked up in December but still looked well behaved. Insurance premiums are one of the areas that are becoming a problem. Hence, the need to continue to see improvements elsewhere.

What is the Federal Reserve doing and what is it trying to accomplish.

The statement and the press conference following the December meeting were much more dovish than many expected and ignited a massive rally in stock and equity prices.

First, the Fed had to know that their statement, which highlighted that we might not need “any” additional rate hikes and that “inflation has eased over the last year,” would trigger a rally. Fed Chair Jay Powell did not push back on that view when at the press conference following the statement. Instead he revealed pivot in his thinking and many (albeit not all) within the Fed. He said ..”we are aware of the risk of hanging on too long…and we are very focused on not making that mistake.”

That statement, coupled with an earlier statement that stronger that potential growth was “not itself a problem” represent a 180 degree shift from the risks the Fed felt it faced in 2022.

The Federal Reserve enters an uncomfortable holding pattern this week. Many on the Fed have been stunned and pleasantly surprised by how rapidly inflation cooled. We have seen the fastest deceleration in inflation outside of three major episodes - post WW-II, the Korean War and the Volcker recessions of the early 1980s. That is amazing news. The debate is whether the trajectory on inflation will remain as rapid as it has been as we move into 2023. The Fed has to weigh several issues.

1) Is there a risk that improvements in inflation could stall - it has happened in the past, especially in an economy where supply shocks are more frequent.
2) When do we move from higher for too long to higher for long enough? The U.S. economy has been remarkably resilient in the wake of rate hikes. However, the way rate hikes work their way through the economy is nonlinear - they don’t matter until they do.

The holidays are upon us. Some thoughts on consumer spending and how the holiday season is likely to play out.

We have yet to feel the full effects of earlier rate hikes and even though mortgage rates have receded from their peak, housing is still unaffordable and contingent on builders moving down on the size of homes they build and offering mortgage rate discounts to unleash the pent-up demand of first-time buyers. Millennials are aging into their prime home buying years with the worst affordability since the mid-1980s. That is one of many reasons consumers are not optimistic, even when they report they are confident in their own jobs.

The level of prices and an inability to achieve what previous generations did, with more education, is a large issue.