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 monetary policy to remain unchanged, as well as the current bond buying program. The market will continue to see zero interest rates with $120 billion in bond purchases each month for now.
Impact of unemployment on the economy
The big questions economists are looking for answers to revolve around how the Federal Reserve plans to end the current QE environment. It seems likely that the Fed will continue to cite the slowdown in the labor market, particularly on the supply side, as one of the reasons for maintaining the current course. Demand for labor has been strong, but businesses are still reporting difficulties hiring employees. Some of the reasons are childcare and high unemployment benefits, which correlate with the pandemic. Since the children have not fully returned to school, the parents may not have been able to seek employment despite their wishes. Unemployment benefits stemming from the pandemic have also been accused of being too generous, causing workers to be laid off.
While this is likely the reason some people stay out of the workforce, wages will continue to be the main driver for employees. As the federal minimum wage debate rages on in Washington, there are a growing number of examples of companies raising their minimum wage and being overwhelmed with online applications. With the unemployment rate above 6% and well above pre-pandemic levels, one of these market forces will give way, either companies will pay more for labor to avoid losing business. , or social problems will return to pre-pandemic norms and workers will be forced back into the market. However, the timeline for this to happen may not match what the market expects.
Impact of inflation on the Fed
Institutional traders do not expect the Fed to signal cutback action until August or September of this year. The earlier this announcement is made, the greater the expected impact for equities, primary growth stocks, as higher interest rates drive multiple compression at an uneven pace. Recent inflation data could be the main driver of Fed action at this point. Last week’s CPI data showed 5% over the past 12 months. Traders were quick to react to the news as a change in the CPI signals inflationary forces which, in turn, are changing the investment environment, Fed Chairman Powell said before feeling on edge. comfortable with inflation above 2% for a decent period. The statement purposely reads broadly, as the Fed will want to keep its options open if inflation suddenly starts spiraling out of control.
One reason the Fed might accept the recent CPI data is that much of the reported inflation is coming from certain areas affected by supply chain issues. The used car market has seen prices increase by 21% over the past 12 months, while the energy index has posted a 28% increase. 5% in the last 12 months. Both of these areas may lead to higher annual inflation data, the energy index remained relatively stable from April to May, while used cars continued to rise. This indicates that other sectors of the economy are starting to see prices rise, which isn’t necessarily a bad thing as long as they don’t spiral out of control. Depending on how one chooses to view this, it can be argued that since inflation comes from two main areas, it may decrease as supply chain issues are alleviated.
Alternatively, it can be noted that, as energy remains relatively stable, the CPI as a whole has seen prices rise again, indicating that other areas are accelerating.
This is exactly the debate the Federal Reserve will have to have in the coming days to determine its best course of action. Markets are still pricing in 2023 before rate hikes, but that timeline is 2-3 meetings away. The language used by Jerome Powell to describe the Fed’s strategy in the face of these inflationary pressures will be interesting and will certainly move the markets.
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