10 months ago • 3 mins
The Federal Reserve (the Fed) could qualify for a gold medal when it comes to pumping up jobs – but as far as inflation’s concerned, there’s still a lot of the race to run.
✍️ Connecting The Dots
The Fed has two responsibilities: keep employment full and inflation around a stable 2%. But the central bank can only do half a victory lap because January’s jobs and inflation reports painted two very different pictures. The first was an absolute blowout: 517,000 jobs added (more than double the month before and shattering economists' estimates of 187,000), a 53-year low in the unemployment rate, and strong wage growth that was higher than expected.
But while promising for workers, the jobs report was probably too hot for the Fed’s liking. The central bank has been aggressively increasing interest rates in an effort to dampen consumer demand and bring down inflation. Problem is, inflation isn’t coming down as fast as hoped. Data this week showed consumer prices increased by 6.4% in January compared to the same time last year. That was only slightly lower than the 6.5% pace recorded the month before, and economists had expected a bigger deceleration to 6.2%. On a month-on-month basis, consumer prices climbed by 0.5% in January – the most in three months and a steep acceleration from December’s 0.1%.
One of the reasons why inflation isn’t falling fast enough goes back to the red-hot labor market, which has bolstered wages and allowed many Americans to keep on spending – even as borrowing costs rise and inflation stays elevated. In fact, separate data this week showed retail sales increased 3% last month from the one before – their biggest gain in nearly two years and easily topping forecasts of 1.9%. Those numbers aren’t adjusted for inflation, meaning that consumer spending outpaced the 0.5% increase in consumer prices for the month by two and a half percentage points.
1. Inflation is likely to stay high for a while.
On top of a blistering labor market, China’s reopening could fuel inflation in the US and the world over. Bloomberg Economics, for one, reckons China’s economic growth will almost double this year to 5.8%, and that could lift global inflation by close to a full percentage point toward the end of 2023. But even putting the labor market and China aside, history tells us that spikes in inflation take a long time to disappear. A study by Research Affiliates looked at surges in 14 developed countries over the past 50 years: when inflation crosses above 8% (the level reached by most of the developed world last year), falling back to 3% usually takes six to 20 years, with a median of over ten years.
2. Interest rates will probably climb to a higher peak than previously thought.
But that doesn’t guarantee a repeat tumble for stocks. That’s because the marginal impact on stock valuations of a one percentage point increase in rates is far less when you start at today’s levels of around 5% in the US, versus when you start from zero. Put differently, rates rising from 0% to 1% hits stock valuations way harder than rates going from 5% to 6%. Arguably, the bigger risk now for stocks is how long rates will remain high, impacting the real economy and, ultimately, corporate earnings.
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