We’ll dedicate today’s Data section to discussing Fed Chair Powell’s press conference today.
Our big picture takeaway: the contours of the US post-pandemic economic recovery are 1) upending the Fed’s assumptions about how it would go and 2) creating uncertainty about the US economy’s 1–2-year future. We’re reminded of the old military strategists’ saying that “the map is not the terrain”. Or, as Mike Tyson famously opined “everybody has a plan until they get punched in the mouth”.
#1: Exactly what is “transitory” inflation? This is how the Fed has characterized the last 3 months of CPI prints, each running at +4 percent. It was clear from today’s press conference that policymakers have been surprised by these hot numbers. Specifically, Chair Powell flat-out said that he has “little confidence” he can call the near-term peak in US inflation, and he has (only) “some confidence” that it will decline in the medium term.
Now, at one level it is easy to see how the Fed missed the move. As we’ve outlined in prior reports, US inflation is currently concentrated in used cars, gasoline, and transportation services (plane tickets, mostly). Outside of those categories, CPI is running around 2 percent.
But here is the problem: these narrow slices of the CPI that are causing hot inflation prints have many more months of easy 2020/2021 comps. The following chart shows CPI inflation for used cars (blue line), motor fuel (red) and transportation services (black) back to the start of 2020. The highlight box shows that these mostly started to move dramatically higher in April 2021. Scan your eye back across the timeseries to the grey recession bar and you’ll see that inflation for these items was much lower (or even negative) over 2H 2020.
Takeaway (1): Chair Powell said “inflation could be higher and more persistent” in coming months, and the CPI math says that’s all but certain. Even if used car, gas and transportation services prices go nowhere for the next 6-9 months, headline and core consumer price inflation will still be well above the Fed’s 2 percent target. We’ll have to get into Q2 2022 before we anniversary the last 3 months’ high levels.
Takeaway (2): Powell took pains today that he doesn’t expect prices to drop once we’re through the “transitory inflation” phase. He simply believes that price increases will revert to 2 percent/year pre-pandemic from thereafter. Market-based measures of expected inflation such as TIPS spreads agree (2.4 – 2.6 percent currently).
#2: What is going on with the US labor market that we have as many job openings as unemployed workers? While Chair Powell has never explicitly said it, the Fed clearly thought that pre- and post-pandemic labor markets would be roughly mirror images of each other. Workers who lost their jobs would be recalled once the economy recovered, plus or minus a small percent. This is why he frequently cited net jobs lost at press conferences earlier this year (“we still have X million people to bring back to work”).
Instead, we have a very hot labor market AND still-high unemployment. There was something of a snapback from April 2020’s 23.1 million unemployed to December 2020’s 10.7 million. But … There’s been almost no progress since – June’s unemployment level was 9.5 million – and, as this chart shows, job openings now sit at 9.2 million.
Now, scan this chart and you’ll see that the 2021 labor market is actually very much like 2019 in one way: job openings (red line) were above total unemployed (blue line) every month of that year. The mismatch of supply and demand existed pre-pandemic and it’s coming back now, albeit at higher levels of joblessness than previously. The problem is not new. It’s just getting more attention because unemployment remains high.
Takeaway: Chair Powell summarized his take on US labor markets by saying “It’s not so much about going back to an old job; it’s about finding a new job” and he characterized this as “an unusual situation”. Workers are “shopping carefully” for their next position, in his view. Neither the Fed nor potential employers really have any idea how long this “shopping” will continue.
#3: Combine these two points and, no surprise, the Fed is still unsure of when to start tapering bond purchases. When asked explicitly, Chair Powell refused to say if the late August Jackson Hole Fed conference would see any news on this front. The most he would say is that he is hoping the July Jobs Report (out a week from Friday) will bring better news on the US labor market.
We don’t have a lot of Fed tapering history to analyze, but the events of 2012 may be some guide. In May of that year then-Chair Bernanke made the off-the-cuff comment at a congressional hearing that started the “taper tantrum”. An actual announcement did not come for 7 months, at the December FOMC meeting.
When we first read today’s Fed announcement and saw the changes to its bond purchasing language, we thought “yep – the tapering clock has started”. Using the same timeline as 2012, we figure that actual tapering will come in early 2022 with an announcement at the January 2022 meeting.
Takeaway: Powell said the Fed is “in process” on assessing tapering and wants to see “substantial further” economic (read “labor market”) progress before it pulls the trigger. Given how differently this recovery has progressed relative to how the Fed thought it would go, we totally understand why the Fed is so cagey on the topic. That will not likely change for at least several more months.