The Fed’s Employment Conundrum
Financial conditions are about as easy as they can be. The Fed is cutting rates and more cuts are expected. Some members of the Fed and the Treasury Secretary have successfully jawboned down the long-end of the Treasury market (and thereby mortgage rates) with talk of a “third mandate”. The US Dollar is hovering around three-year lows. Credit is available to corporations in an unprecedented manner. Capital expenditures, while concentrated in tech, are surging. The willingness of Americans to speculate has never been higher whether it be crypto, 3x levered ETF’s or NFL parlays. Equity markets are making all-time highs at near all-time high valuations on a weekly basis. Yet, demand for labor is essentially dormant. This is the issue facing Chairman Powell and the Fed. Monetary and fiscal accommodation have reached the level of moral hazard where bubbles seem to be floating all around us and yet that hasn’t been enough to stimulate hiring.
Yesterday, Chair Powell said, “There is no risk-free path on policy.” In other words, both sides of the dual mandate are going in the wrong direction. Yesterday, Powell acknowledged that tariff driven inflation remains early days and the gradual pass through of these taxes to the end consumer will build for some time to come. The most recent CPI report showed core and headline inflation running at 3%. That incremental rise in inflation is driven entirely by the goods sector despite oil prices languishing at $60. Is the Fed supposed to ignore inflation running 50% above their target for the 5th year in a row or are they supposed to respect what markets are telling them, which is that they needed to “take the punch bowl away” quite a bit earlier in the evening.
The labor data that we do have amid the government shutdown show employment trends continuing toward a mild contraction. The question though is why? Is it cyclical? Is it a reflection of weak demand? Is it just a reflection of a shrinking availability of labor due to aging demographics and deportations? Is it AI? Is it due to excess hiring that occurred post the pandemic? My guess is that all of these factors have contributed to the weak labor market. The problem is that few of these factors are actually helped by lower Fed Funds.
To make things a good bit more confusing for the Fed, there is also the increasingly accepted economic argument, largely put forth by the devotees of Modern Monetary Theory or MMT, that argues the Fed and mainstream economic thinking has it all backwards. They essentially make the case that we live in a whole new world where Baby Boomers have most of the savings and that cohort’s spending tends to rise with higher interest rates and it falls amid lower interest rates. In other words, by cutting rates at the front end and suppressing rates at the long-end, while it may encourage more risk taking, it is actually counter-productive in that there is a negative wealth/income effect on a cohort that is a core driver of demand. It is an argument that I have come to believe has some credibility. The demographic reality of the US economy is clearly getting older and with that, the economy is increasingly reliant on the spending and wealth transfer of these older savers. They represent a big part of the 10% of Americans who drive 50% of all consumption.
The point here is that we don’t know the future and neither does any Fed Governor. Precedent isn’t always prologue because the economy is always evolving. Never before have our demographics or wealth bifurcation looked the way they do now. Never before has our fiscal policy been so accommodative that we have war time deficits amid full employment. A monetary policy that made sense in the 20th century might be far less effective in current times. Our only recommendation for the various members of the Fed is to have a little humility. You don’t know the future and you don’t know the consequences of running an economy this hot for this long. For investors, we offer a simple reminder that momentum works in both directions and there may come a time in the near future where it has become clear that there isn’t always an effective Fed put.
Tim Pierotti is WealthVest’s Chief Investment Strategist.
Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.
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