It will take both the US labor market fully recovering and inflation reaching 2 percent sustainably for the Federal Reserve to even consider raising near term rates. That’s the latest from Fed Chair Powell today at a virtual event hosted by the Economic Club of Washington, who doesn’t think that will happen before 2022.
While Chair Powell may seem like a broken record stuck on data-driven future Fed policy, we’ve also seen that one qualitative Fed report influences his thinking: the Beige Book, of which he is a vocal proponent. We’ve written about this report when it is out eight times a year for over half a decade because it provides a lens into the business conditions that Fed policymakers’ contacts share with them. This “on-the-ground” color has only grown in importance over the last year given the changing nature of the Pandemic Recession.
Therefore, we’ll give our usual review of the latest edition, but first offer an update on three hot button issues we measure by tracking how many mentions they receive in each edition of the Beige Book:
Virus-related terms: There were just 24 mentions of the virus in this month’s report, down from 46 references last month and 58 in January.
Vaccine: There were 20 references to “vaccine/vaccination” compared to 29 in March but just 10 in January.
Stimulus: There were 15 mentions of “stimulus” versus 12 in March and 2 in January.
Takeaway: references to the virus were the lowest since they first showed up in March 2020. Mentions of the vaccine are double what they were in January and stimulus showed up more than March as Americans received their checks. These trends capture the growing optimism of the Fed’s contacts: “Outlooks were more optimistic than in the previous report, boosted in part by an acceleration in… vaccinations.”
Now let’s get into the details of the report with our 3 main takeaways:
#1: Economic Growth: “National economic activity accelerated to a moderate pace from late February to early April.” That’s up from most districts expanding “modestly” during the first 6 weeks of this year. Consumer spending “strengthened” after being mixed in the last report. There was also a boost in demand for leisure activities and travel due to a combination of spring break, lessening virus-related restrictions, more vaccinations and recent stimulus payments.
Other areas of strength included auto sales despite microchip shortages constraining new-vehicle inventories, and manufacturing activity, with “half the districts citing robust growth” despite supply chain disruptions. Additionally, prices for single-family homes continued to rise amid high demand and tight supply, while builders continued to face increasing costs.
#2: Employment: The report characterized employment growth as “modest to moderate”, an improvement from rising “slowly” in the last report. That said, the “pace of job growth varied by industry but was generally strongest in manufacturing, construction, and leisure and hospitality.” Hiring “remained a widespread challenge, particularly for low-wage or hourly workers”, such as commercial/delivery drivers and specialty skilled tradespeople. Some districts, such as Atlanta and Minneapolis, said unemployment insurance made it more difficult to attract workers. Childcare also remains an issue.
On a more positive note, “some firms noted absenteeism due to [the virus] was down” and “employment expectations were generally bullish”. Wage growth rose slightly, particularly in industries where finding and retaining workers remains a challenge, such as in manufacturing and construction. To combat these issues, some of the Fed’s contacts increased starting pay or offered signing bonuses.
#3: Inflation: Input costs “rose across the board, but especially in the manufacturing, construction, retail, and transportation sectors—specifically, metals, lumber, food, and fuel prices.” This was due to supply chain disruptions, a growing problem as mentions of “supply chain” went from just 9 in January to 21 in March and 28 in the latest report. For example, Philadelphia said “severe myriad supply constraints continued to hamper potential growth from demand described as “on fire”.”
Beige Book references to “inflation” are also creeping higher, from 6 in January and March to 9 in April. For example, Boston said its contacts “expressed concern about rising inflation over the rest of the year.” While there “were widespread reports of increased selling prices”, they were not usually “on pace with rising costs”. Going forward, the Fed’s contacts “generally expect continued price increases in the near term.”
Bottom line: economic growth and consumer spending accelerated over the last 6 weeks and pent-up demand for leisure activity and travel are starting to materialize. Inflation has picked up and companies face both labor shortages and supply chain disruptions. In the end, we continue to agree with the Fed that near-term inflation is transitory rather than structural, so we don’t think Chair Powell will view these inflationary pressures as a major red flag. Moreover, the latest Fed Beige Book reports continue to show employers’ challenge of pulling workers back into the labor force. That will take time as vaccines roll out and childcare becomes more accessible, factors that are out of Chair Powell’s control. That’s why he and the Fed continue to signal holding rates near zero through at least 2022 to let the economy run hot enough to achieve their dual mandate.