WednesdayJay Powell faced reporters with confidence after the Fed's first policy meeting of 2024.
The Fed chair praised "six months of good inflation" and more to come, saying, "Let's be honest: it's a good economy. ”
Maybe a little too good. On Friday, markets were stunned by data released by the U.S. Bureau of Labor Statistics, which showed that the U.S. economy added 353,000 jobs in January, almost double expectations.
Wall Street immediately ruled out a rate cut in March due to the blowout of jobs data – Powell has already indicated that a rate cut is unlikely.
Against the backdrop of steadily weakening inflation, central bankers around the world have begun to prepare for interest rate cuts. But as the U.S. employment data shows, a hot labor market is the biggest potential obstacle to their 2% inflation target.
Eswar Prasad, an economist at Cornell University, said Friday's data made declaring a victory in the fight against inflation a "more worrying" decision for the central bank. "The reality is that under these pressures, it will be very difficult to bring inflation under control unless productivity growth remains strong. ”
This is not to deny how significant the improvement in inflation conditions is. A year ago, the Federal Reserve and its peers were in the midst of a brutal series of interest rate hikes, which some feared would tip the economy into a recession.
Powell warned in February 2023 that they still have "a long way to go" as they try to calm the "significant difficulties" caused by the highest inflation in 40 years. Since then, inflation has fallen to the Fed's 2% target, based on a range of different indicators.
ECB President Christine Lagarde, who announced in Frankfurt on 25 January that the "deflationary process" is working, is equally positive about the situation in the eurozone. The overall price growth rate in the EU is currently 28%, not far from the ECB's 2% target.
January 2023 (8.)6%) to January 2024 (2.)8%), % percentage points of the decline in HICP inflation in the euro area during the period.
Bank of England Governor Andrew Bailey told reporters in London last Thursday that price inflation in the UK had halved to 4% in six months and that he saw "good news on inflation."
The pace at which inflation has come back in recent months has caught many rate-setters off guard. According to the International Monetary Organization, consumer growth in advanced economies has fallen from more than 7% in 2022 to 46%。
The last week's note noted that inflation will fall further to just 2 this year6%, well below the previous 3%**, and four-fifths of the economies it tracks will experience lower annual headline and core inflation in 2024.
Mahmood Pradhan, head of global macroeconomics at Amundi Investment Institute, believes that inflation trends are now "clearly declining and it is only a matter of time before interest rates are cut sharply this year".
"Out of an abundance of caution, central bankers want to wait a little longer, but I can see the Fed, the ECB and the Bank of England all cutting rates in the middle of the year," he added. ”
The continued progress of the deflationary story will largely depend on the fate of the labor market. While the initial decline in inflation was driven by external factors, progress now hinges on the more difficult task of curbing domestic** growth. This will become more difficult if employment and wage growth remain too strong.
Economists say that to erase the last vestiges of excessive growth, policymakers will need to maintain a sustained hawkish policy that further dampens demand.
All this speaks to a concern that has been plaguing central banks** for months: Will the "last mile" of bringing price growth down to the 2% target prove to be the most difficult? If this is the case, central banks will have to be especially patient before cutting interest rates.
Among the major central banks, the Fed** seems to have been the least worried about getting through the final stages of its inflation-fighting journey.
Powell himself expressed doubts about this concept in December. "Inflation continues to fall," he said. "So far, so good – although we think it's going to be more difficult from here. But so far, not yet. ”
The Fed's confidence is partly due to the nature of inflation in the United States and the speed at which it has fallen. While the U.S. has been hit hard by COVID-related chain disruptions, it hasn't seen the kind of energy spike that followed Russia's invasion of Ukraine that pushed up across Europe. As a result, US inflation never reached double digits and reached 91% peak.
The nature of the inflation shock also makes its reversal more rapid. On some indicators – including the six-month core personal consumption expenditures gauge, which the Fed says provides the best signal of potential pressures – inflation is currently below 2%.
But on Friday, fears of an overheated job market resurfaced. In addition to January's blowout data, December and November data were revised upwards, with average hourly earnings rising by 4., according to the Labor Bureau5%。
Diane Swonk, chief U.S. economist at KPMG, said the unusually low rate of layoffs and fewer hours worked suggests that part of the strength of the job market is due to employers "hoarding" labor. She explained that those who struggled to hire workers after the Covid lockdowns ended did not want to find themselves in the same situation when demand picked up.
However, the salary at the beginning of the year was still much higher than usual," she added. "Considering the upward revision in the previous two months and higher-than-expected wage growth, this suggests that the labor market may be re-accelerating. ”
Curt Covington, senior director of farmer credit provider AgAmerica Lending, said wage pressures remain high in states like California, with the statewide minimum wage rising another 50 cents this year to $16 an hour, up from $12 an hour when the pandemic hit.
[The production] of certain commodities is very dependent on labor, especially specialty crops," Covington said. "You don't see labor costs increasing too much for Midwestern crops like corn and beans, but when you get into some specialty crops like fruits and vegetables, labor costs go up significantly. ”
Some economists fear that the price deflation caused by the easing of chain pressures will soon end, and the work to curb overall price growth will be more difficult. Given the strong demand in the United States, the economy grew at an annual rate of 33%, which is especially important.
Pradhan argues that stubbornly high wage growth is the main question mark for central bankers as they prepare for the "last mile" of their deflationary journey.
Wage growth has slowed, but remains a major concern for policymakers.
But he remains optimistic. He argues that wage growth in the U.S. should be benign because it is supported by strong productivity growth. In Europe, weak economic demand should lead to a "continued slowdown".
Others point out that the Fed is facing a situation that is very different from the terrible wage** spiral that occurred in the '70s and early 1980s of the 20th century. "Inflation during this period is mostly not related to demand. Claudia Sahm, a former Fed economist and founder of SAHM Consulting, said: "The pandemic has caused disruption to the ** chain, the labor market, and spending. ”
Productivity still looks very good," she added. "The U.S. economy can tolerate higher wages. ”
The ECB's rate-setters have made it clear that the main focus in the coming months will be on wage settlements and whether they are in line with the 2% inflation target.
Back in December, Bundesbank President Joachim Nagel warned that inflation was a "stubborn and greedy beast" and that reducing it needed to "grit your teeth and not let up". Nagel's attitude has sounded more optimistic lately, with him saying at an event in Berlin last week that the beast had been "tamed".
But Lagarde has been warning that it is "premature" to discuss a possible rate cut at this stage – mainly because of wages**. The concern from the ECB and elsewhere is that workers will demand large wage rises to restore the purchasing power they lost during the initial spike in prices. As the increase in spending power enters the economy, it will trigger a new round of ***
Last year, wages in the eurozone exceeded 5%, close to the annual inflation rate. Despite recent data showing that wage pressures have "declined", Lagarde said the ECB still wants to ensure that companies that choose to lower their profit margins rather than raise their margins "fully absorb" higher labour costs.
Eurozone inflation has gone from a record 106% has steadily fallen below 3%, but Lagarde has expressed concern that one sector that appears to be more viscous is the services sector, where labor accounts for a large portion of total costs. Eurozone services ** 4% for the third consecutive month in the year to January.
As in the United States, these concerns have been underpinned by the unexpected resilience of the region's labor market. The unemployment rate in the Eurozone remained unchanged at 6 in DecemberAt an all-time low of 4%, many companies – especially in the service sector – are still complaining that labor shortages are a major constraint on production.
But like in the United States, optimistic economists have dismissed the notion that Europe is in the midst of a wage-** spiral, noting that, with the exception of a few countries such as Belgium, the automatic "indexation" of wages and ** has largely disappeared.
Sven Jari Stehn, chief European economist at Goldman Sachs, said a key difference from previous periods of high inflation is that wages seem to follow rather than lead. It's natural that when the shock pushes the grid, it has a lagged effect on wages, but the risk here isn't that great," he said.
Despite the tight labor market, it may be difficult for many companies to pass on higher wage costs because, unlike in the United States, the underlying economy is stagnating. So while unions last week demanded a 6% to 7% pay rise for German chemical workers, it seems unlikely that this would trigger a spike in an industry** that saw an 11% drop in production last year. “
The one-time ** of wages ** is very different from the spiral**," said Marcel Fratzscher, former ECB** and now head of the German Institute for Economic Research in Berlin. "The ECB should consider a one-time adjustment. ”
ECB rate-setters have privately said they are confident in this. "We see metrics moving in the right direction," said one of its management committee members. "Monetary policy is working. Inflation is falling. ”
The Bank of England's ** doesn't sound so reassuring – or at least not yet. This is despite Bailey keeping interest rates at 5 on his policy committee last weekThe door to a rate cut was finally opened after 25%, but the head of the Bank of England seems to be cautious on the topic of rate cuts, as if mentioning the idea loudly would provoke unnecessary relief. on the market.
The bank warned that while the UK labour market has cooled, it remains tight "by historical standards" as it continues to highlight indicators of persistent pressures such as wage growth and services inflation. A survey by the Bank of England regional** shows that the average salary settlement rate will fall to 54%, which is not far from last year's 6%.
Concerns about other "upside risks" to inflation have heightened the caution of central bankers. One of the obvious reasons for this is the ongoing conflict in the Middle East. Disruptions to shipping caused by Houthi attacks on ships in the Red Sea are widely seen as a factor that could push inflation higher than expected. Given the importance of the ** route for imports from China, Europe seems to be particularly vulnerable.
However, rate-setters, including Christine Lagarde of the European Central Bank, tend to downplay the issue, pointing out that shipping accounts for only 15%。Economists seem to agree. Goldman Sachs estimates that the ** of container freight will only bring 01 percentage point impact.
Even the ECB's new AI-driven inflation** model shows that inflation will be much lower by this summer than it was a few weeks ago, close to 2%.
Still, banks may remain vigilant to avoid jumping too early and then be forced to abruptly change direction when inflation spikes again. The International Monetary Organization warned last year that central banks have a rich history of prematurely declaring victory over inflation.
Among them is the United States itself, where Fed Chairman Arthur Burns was accused of being too loose on price growth in the early 70s of the 20th century – failing to address the scourge that plagued the US economy for a whole decade.
Krishna Guha, a former Fed** and now vice chair of investment bank Evercore-ISI, said the rapid reversal of the driven inflation combined with stubborn growth at home has left central bankers facing a delicate balancing act.
"You want to make sure that you don't jeopardize a soft landing by being too tight for a long time," he said. The work isn't quite complete yet, but they're pretty close – in some cases very close – to getting there. ”
Sam was more confident, saying the market "has had good data for months".
This (January) jobs report doesn't change the fact that it's going to be the toughest first mile, not the last. ”