At this point, it’s logical to ask the question, “what does the Fed need to see to determine that they no longer need to raise rates?” Clearly, inflation numbers have come way down from their 2022 peak. It is taking longer for unemployed workers to find work, and the money supply is falling. The recipe is here, and last month’s pause suggests the Fed may be ready to evaluate how tightly they need to adhere to their “Data dependent” actions. But what now? Last week the Fed raised another 25 bps, and there is a clear expectation for at least one more 25 bps increase before year-end. Will that be it? Chairman Powell has been very clear that he does not feel that their work is done, and that they will continue to rely on the data.
But the data is lagged. You know that, we know that, and the Fed knows that. The recent pause suggests that the Fed can acknowledge the lag, but when targeting 2% inflation, can they really stop raising rates before they get there?
Something that does not get a lot of press, that is a statistical contributor to these data, is the labor participation rate. While these numbers have been improving since the early stages of the pandemic, there has been a particularly large uptick this year among prime-age workers (25-54 years old), and women in particular. The reason this matters, is because it changes the calculation of the model outputs the Fed uses. On the way up, it’s really not very obvious because those who didn’t appear to be participating were unlikely to be counted.
But if the economy takes a negative turn, those folks that are participating will show up very quickly as they lose their jobs. The Fed is very conscious of these changes and making sure to accommodate whatever situation arises. They have to be, because the reality is, if they get this wrong, the numbers will skew against them very quickly.
We believe that the Fed is going to move as conservatively as they can in coming months. Where they have historically tried to give investors as much information as possible, they are likely to be less forthcoming at the next inflection point. It’s likely time to stop, but they have to maintain flexibility in case investors are wrong.