Economic strength forces the Federal Reserve to become more aggressive

On Tuesday, we learned that American employers have a record number 11.5 million job opportunities As of March. This is arguably the clearest sign that the economy is booming, because hiring workers isn’t cheap and most employers will only do so if they don’t already have the staff to keep up with demand.

Currently, there are only 5.9 million unemployed. In other words, there are approximately Two vacancies for each unemployed person. A mismatch means workers have a lot of options, which means they have a lot of leverage to demand more pay. Indeed, Employers pay at a historical rate.

But increasing demand, record job opportunities, higher wages…it’s all about it bad?

Federal Reserve Many workers in the economics profession do not describe it frankly. But it works their message.

playing condition: The demand for goods and services has greatly exceeded supply,1 that was sent Inflation to high contract rates. This is partly due to the fact that higher wages mean higher costs for businesses, which many have been Raising prices to maintain profitability. Ironically, these higher wages helped promote Already strong financials for consumerswho pay willingly, thus essentially enabling companies to keep raising prices.

It is important to add that this booming demand has been boosted by job creation (ie the phenomenon in which a person goes from earning nothing to earning something). In fact, the United States created a huge volume 2.1 million jobs In 2022 so far.

The Bureau of Labor Statistics has a measure called the Index Total weekly payrollIt is the product of jobs, wages and hours worked. It is an approximate proxy for the total nominal spending capacity of the workforce. This measure is up 10% year over year in April and has been up 9.5% since April 2021. Before the pandemic, it was trending around 5%.

This combination of job growth and wage growth has exacerbated the problem of inflation.

So it seems that the best solution at this point is monetary tightening So that financial conditions become more difficult, which leads to a cooling of demand, which in turn should alleviate some of these persistent inflationary pressures.

In other words, the Fed is eliminating some good news coming from the economy because that good news is actually bad.2

Fed moves to cut ‘excess demand’ 🦅

at widely awaited move the The Federal Reserve raised short-term interest rates on Wednesday by 50 basis points to a range of 0.75% to 1.00%. This was the central bank’s largest increase in a single announcement since May 2000.

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Moreover, Federal Reserve Chair Jerome Powell indicated the intention of the Federal Open Market Committee (the Federal Reserve Committee that sets monetary policy) to maintain interest rate hikes at a robust pace.

“Assuming economic and financial conditions develop in line with expectations, there is a general feeling with the committee that additional increases of 50 basis points should be on the table at the next two meetings,” She said. “Our overall focus is on using our tools to bring inflation down to our 2% target.”

To be clear, the Fed is not trying to force the economy into a recession. Instead, it tries to get the excess demand – as evidenced by the presence of more jobs than the unemployed – more in line with supply.

“There’s a lot of excess demand,” Powell said.

Federal Reserve Chairman Jerome Powell (Getty Images)

Federal Reserve Chairman Jerome Powell (Getty Images)

Currently, there is Great economic windIncluding Excess consumer savings And Capital expenditure orders boomThat should drive economic growth for months, if not years. Thus there is room for the economy to let go of some of the pent-up pressures from demand without entering a recession.

here more of Powell’s press conference Wednesday (with related links added):

The situation would be much more dire if consumer and commercial finances were depleted in addition to the lack of excess demand. But that is not the case now.

Thus, while Some economists say That the risk of a recession is rising, most of them do not consider it a base case scenario for the near future.

Is it bad news for stocks? not nessacary.

When the Fed decides it’s time to cool down the economy, it does so by trying to tighten financial conditions, which means the cost of financing things is going up. In general, this means a combination of higher interest rates, lower stock market valuations, a stronger dollar, and stricter lending standards.

Does this mean stocks are doomed to go down?

Well, a hawkish Fed is definitely a risk to stocks. But nothing is ever certain when it comes to forecasting stock price prospects.

First of all, history says Stocks usually rise when the Fed tightens monetary policy. It makes sense to remember that the Fed tightens monetary policy when it thinks the economy has some momentum.

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However, the possibility of higher interest rates is certainly a concern. Most stock market experts, such as billionaire Warren Buffett, generally agree Higher interest rates bearish to Reviewssuch as the next 12-month (NTM) price-to-earnings ratio.

But the key word is “valuations,” not stocks. Stock prices don’t need to fall to lower valuations as long as earnings expectations are rising. And Profit expectations are rising. and in fact, Ratings have been dropping for months.

Chart below By Jonathan Golub at Credit Suisse captures this dynamic. As you can see, NTM’s P/L has been trending lower since late 2020. However, stock prices have mostly been on the rise during this period. Even with the recent market correction, the S&P 500 is higher today than it was when valuations started falling. why? Because the profits for the next 12 months will basically go up.

To be clear, there is no guarantee that stocks will not continue falling from their January highs. It is certainly possible that future earnings growth will turn negative if the business environment deteriorates.

But for now, the earnings outlook remains remarkably resilient, and that could provide some support for stock prices, which are currently being trialled. Very typical sale.3

More from TKer:

rear view 🪞

📉📈📉📈 Stocks go to waste: The S&P 500 is down only 0.20% To round off an incredibly volatile week. On Wednesday, the S&P rose 2.99% in what was the largest one-day rise on the index Since May 18, 2020. The next day, it was down 3.56% from what the index was The second worst day of the year.

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The S&P is currently down 14.4% from its January 4 high of 4,818. To learn more about market volatility, read This is amazingAnd This is amazing And This is amazing.

💼 job creation: US employers added 428,000 healthy jobs in April, according to BLS data Released on Friday. This was well above the 380,000 jobs Economists predict. The unemployment rate was 3.6%. For more information on the state of the labor market, read This is amazing.

📊 Service activity growth cools: According to survey data collected by Institute of Supply ManagementService sector activity slowed in April. From Anthony Neves, Chair of the ISM Services Business Survey Committee: “Growth continues in the services sector, which has expanded for the past 147 months except for two. There has been a decline in the composite index, mostly due to the pool of restricted employment and slowing growth of new orders. Still going strong. However, high inflation, capacity constraints and logistical challenges are drawbacks, and the Russo-Ukrainian War continues to affect material costs, most notably fuel and chemicals.”

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up the road 🛣

There is no bigger story in the economy right now than the trend of inflation. So all eyes will be on the April Consumer Price Index (CPI) report, which will be released on Wednesday morning. Economists estimate that CPI rose 8.1% year over year during the month, which would be a slowdown from 8.5% print March. Excluding food and energy prices, core CPI is estimated to have risen 6.1%, down from 6.5% in March.

Check the calendar below from Release With some big names announcing their quarterly financial results this week.

1. We won’t go into all the nuances of supply chain issues here (for example, how labor shortages in the United States, COVID-related shutdowns in China, and the war in Ukraine are disrupting manufacturing and trade). However, we know that supply chain issues still exist as evidenced by constantly slow Supplier delivery times.

2. For those of you new to TKer, I’ve written a little bit about how good economic news has been “bad” news. You can read more about it hereAnd hereAnd hereAnd here.

3. Investing in stocks is not easy. this means Having to deal with a lot of short-term volatility while you wait for those long-term gains. Everyone is welcome to try to time the market and buy and sell in an effort to minimize those short-term losses. But of course, risk misses those big spikes that occur during periods of volatility, which can irreversibly damage long-term returns. (Read more hereAnd here And here.) Remember that there is an entire industry of professionals aiming to beat the market. Few are able to outperform in any given year, and of those who do, Few of them are able to continue this performance year after year.

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