Ecoinometrics - Bad news for risk assets: the Federal Reserve is running on hard mode
What to do when the economy doesn’t deteriorate fast enough?
Despite the Federal Reserve trying hard to kill the US economy, it is still hanging there. So what is the FOMC to do about that and how will that influence your investments?
Plus in the second part of the newsletter we review where Balaji’s Bitcoin bet is at.
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Bad news for risk assets: the Federal Reserve is running on hard mode
What the Fed wants
Here is a recap of what the Federal Reserve is doing:
The FOMC is raising rates and trying to contract its balance sheet to make the credit conditions much tighter in the US economy.
Achieving that would have the consequence of slowing down the business activity which should lead to a looser job market and lower wages.
Ultimately that would result in a much weaker economy and keep inflation under control.
Now clearly this is a balancing act for the Federal Reserve. As we have seen in the past few weeks they also need to make sure the financial system doesn’t completely collapse on the way to put the lid on inflation. But so far they have been doing an ok job at that.
Of the three stages summarized above stage (1) is very advanced. Which means we should start seeing the effects on stage (2). But unfortunately for the Federal Reserve this is not really the case. For some reason the economy has proven very resilient to the most aggressive rate hike sequence of the past 50 years.
A stubborn job market
Nowhere is this fact more clear than in the jobs market data coming out of the non-farm payroll report that was released last Friday.
The unemployment rate is very low, even historically low. It took about two years but the US has completely recovered from the COVID crash.
And this is not some “artificial” low unemployment rate. Because when you look at the total number of persons employed in the US, we are now above the pre-pandemic level. So job participation is there.
On top of that hourly wages continue to climb which is another sign that the job market is relatively tight.
The only thing that the Fed might like in that report is that job openings are cooling down. But the number is still much higher than the pre-pandemic level.
Give it a few more months at this rate of decline and the data will end up aligned with the long term trend though. So that’s still a good sign the job market is getting back to a more normal dynamic.
Now as we have observed before this is not an exceptional situation in the months leading to a recession. The job market always severely deteriorates during a recession. But this is never the first metric to go to shit when the economy nose dive. Usually massive layoffs only happen as a last resort when employers don’t have any other choice.
So this is not really a surprise. And the recession clock is still ticking.
The problem is that because the data is not clear cut the Federal Reserve doesn’t know if they have done enough yet to make that inevitable. Which means they could be tempted to overdo it with the tightening cycle in order to make sure they’ll be remembered as those who slayed inflation.
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