Weekly Wisdom – February 2, 2023

By Hightower Great Lakes on February 2, 2023

We Are Approaching the End of Rate Hikes

The Fed raised their target rate 25 bps, the smallest hike since the rate hike cycle began last March. Fed commentary was more balanced than we have heard in a long time.

Fed Chair Powell acknowledged disinflation in goods and the housing services pipeline. Yet, the Fed remains focused on the high core services ex-housing inflation, which represents 73% of CPI. Inflation across services ex-housing is influenced by the tight labor market and coinciding wage growth, which remains high.

The question that prevails: what does the Fed do next? Inflation is retreating broadly. The labor market remains tight, but is showing signs of loosening with the slower pace of wage growth and corporate layoffs.

There are pockets of strength and weakness in the economy, and we see an opportunity for the Fed to take a step back and analyze the (lagged) impact from 450 bps of rate hikes. The Fed has shifted their policy decision-making from considering the “pace” of rate hikes to considering the “extent” of rate hikes.

We think the Fed raises a final 25 bps in March and rates stay high for a while. The bond market continues to price-in a pivot (rate cuts) in the second half and Chair Powell said they will remain “data-dependent.”

A pivot will likely depend on the pace of disinflation. This is the first time Chair Powell left the door open on the pivot/pause narrative.

Fed Chair Powell thinks that a strong labor market, better inflation data, infrastructure spending and other factors will support positive economic growth throughout 2023.

Fed Leaves the Door Open for Future Policy Decisions

The Fed’s narrative remains that they will stay “data-dependent” and there’s still “more work to do.” CPI (inflation) and ECI (wages) are two important figures that will influence the Fed’s March policy decision.

Chair Powell said that we are in the “early stages of disinflation” and “more disinflationary pressures could boost economic activity.” CPI has retreated from 9.1% to 6.5%, a fast pace driven by commodity disinflation. But considerable progress must be made before inflation reaches the Fed’s 2% objective.

The Fed remains strongly resolved to bring inflation to 2%. Chair Powell does not expect rate cuts in the current year and a pause depends largely on the labor market data. The labor market remains tight – it’s difficult to tell how wage-inflation might continue to impact total inflation, particularly services.

We think it’s likely that steady disinflation continues and the jobs market remains tight between now and March. This might lead the Fed to raise 25 bps in March. That will likely be the final rate hike, which would bring the peak target range to 475-500 bps (up from 0 to 25 bps a year ago).

After March, the Fed will continue to analyze the data. Depending on the continued direction of inflation and labor market conditions, they may cut rates in the second half – that is what the market has priced.

Fed Closely Watching Inflation and the Jobs Market

Numerous economic reports are reflecting strength in the jobs market. Currently, wage inflation remains sticky, and while wage growth has slowed, it is still reflecting a tight labor market and places upward pressure on inflation, particularly service-oriented industries.

Chair Powell did not take a hard stance on whether service-inflation might retreat without a larger impact on the labor market.

Chart 1: Job Openings and Employment Costs Reflect Strong Jobs Market, Pace of Wage Growth Slowing¹

Chart 2: Commodities Leading Broad Disinflation Trend, Fed Paying Close Attention to Services Ex-Housing Inflation²

Click here to read last week’s Weekly Wisdom (1/26).

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¹ Source: FactSet (chart). As of February 1, 2023.

² Source: FactSet (chart). As of February 1, 2023.