Professor Siegel's Weekly Commentary Archive
A Challenge to My Thesis on Fed Tightening
February 21, 2023
The last ten days of economic data—starting with January’s labor market report to the recent inflation reports—are certainly presenting a challenge to my thesis that the Federal Reserve (Fed) should stop their tightening. But it is also premature for the hawks to carry the argument as well. Before the next Federal Open Market Committee (FOMC) decision point, we will have another employment report and another series of price reports.
It is unlikely that February data will come in as hot as January’s. But if it does come in that hot, a 50-basis point (bp) hike like Loretta Mester and James Bullard have been discussing could be on the table. Neither Mester nor Bullard are voting members at the FOMC this year and voting members have not been vocal for going more than 25. But I don’t think the data will support a 50 bp hike. It is quite possible we could have lower employment in February which would shut down the chances of going 50.
On the inflation front, energy prices are cooling off and we should not see the same energy price pressure in the next inflation report. If we substitute current housing prices from Zillow rental indexes and Case Shiller Home Prices Index into the Consumer Price Index (CPI), there are now four consecutive months of negative inflation prints for Core CPI. I refer to this calculation of the CPI as the true inflation in the system. The true inflation currently shows much lower inflation than the official statistics, while in 2021 it was much higher than the officially reported data from the Bureau of Labor Statistics (BLS). The Fed finally pivoted from discussing the Core CPI to discuss Core Services ex-shelter—acknowledging the improvement in real time shelter prices. But Core Services ex-shelter has a much smaller base of prices to form a view that there is elevated inflation pressures in the system that requires further restrictive policies.
The Producer Price Index (PPI) also came in hot last week. Jobless claims also came in rather hot, despite manufacturing indexes coming in quite depressed and housing starts also quite soft. Homebuilder sentiment jumped a bit, but that coincided with lower mortgage rates that spiked over the last two weeks that will weigh on sentiment ahead again.
My biggest worry remains that monetary policy acts with a long and variable lag. We stated tightening policy less than one year ago at the March FOMC meeting. We made a lot of progress on reducing the surging prices, while overall real economic activity is not growing at very elevated levels.
I will also say the Federal Reserve does not know what policy it will take until 10-15 days before the meetings. The Fed may have a ‘Dot Plot’ that gives current forecasts, but history shows this can move very quickly as new data comes in. We must stay nimble in our assessments until we see more data come through.
Given the sharp rise in interest rates in the last two weeks, the equity markets held up well. The most bearish forecasters were penciling in a drop to earnings on an economic slowdown. Rates are rising because employment data is coming in strong and the economic data is holding up quite well, so earnings estimates are more likely to materialize.
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