On the afternoon of June 16, Fed Chairman Jerome Powell will announce the decisions of this week’s Federal Open Market Committee meeting. Almost all market participants expect an unchanged monetary policy and the current bond purchase program. The market will continue to see zero interest rates for now with 120 billion bond purchases per month.
Effects of unemployment on the economy
The big questions economists are seeking answers to revolve around the Federal Reserve’s plans to end the current QE environment. It is likely that the Fed will continue to point to a slump in the labor market, particularly on the supply side, as one of the reasons for holding current course. The demand for labor has been strong, but companies are still reporting difficulties in hiring employees. Some reasons are childcare and high unemployment benefits, which are correlated with the pandemic. Since the children are not yet fully in school, parents could not look for work despite a request. Unemployment benefits from the pandemic were also accused of being overly generous, which resulted in workers remaining unemployed.
While this is likely the reason some people are inactive, wages will continue to be the main reason for workers. As the state minimum wage debate rages in Washington, there are more and more examples on the Internet of companies raising their minimum wages and being flooded with applications. With an unemployment rate above 6% and well above pre-pandemic levels, one of these market forces will subside, either companies will pay more for their workforce so as not to lose business, or social problems will return to pre-pandemic norms, and workers are forced to return to the market. However, the schedule for this may not be what the market expects.
Effects of inflation on the Fed
Institutional traders don’t expect the Federal Reserve to signal a reduction in measures until August or September this year. The sooner that announcement is made, the greater the shock would be to what one would expect to be primary growth stocks, as higher interest rates result in multiple, uneven rate compression. Recent inflation data could be the main reason for Fed action at this stage. Last week’s CPI data showed a 5% increase over the past 12 months. Traders were quick to respond to this news as a change in CPI signals inflationary forces which, in turn, will change the investment environment, said Fed Chairman Powell, before they are comfortable with inflation above 2% for a reasonable time. The statement is deliberately broad, as the Fed wants to keep its options open should inflation suddenly spiral out of control.
One of the reasons the Fed is accepting the latest CPI data is because much of the inflation reported comes from some areas affected by supply chain issues. In the used car market, prices have increased 21% in the last 12 months, while the energy index has increased 28.5% in the last 12 months. These two areas could pull up the annual inflation data, the energy index stayed relatively flat from April to May while used cars continued to rise. This suggests that prices are rising in other areas of the economy, which isn’t necessarily a bad thing as long as they don’t get out of hand. Depending on how you look at this, it can be argued that since inflation comes from two main areas, inflation can subside as supply chain problems are mitigated.
Alternatively, it can be pointed out that while energy was relatively flat, the CPI was still seeing higher prices, suggesting other areas are gaining momentum.
This is exactly the debate the Federal Reserve must have in the days ahead to determine its best course of action. Markets are still projecting 2023 before rate hikes happen, but that schedule has shifted earlier in the last 2-3 sessions. The language Jerome Powell uses to outline the Fed’s strategy in relation to these inflationary pressures will be interesting and it will certainly move the markets.
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