Wilson Phillips Fed
They held on for one more day. As a surprise to absolutely no one, the Federal Reserve Open Market Committee (FOMC) held its policy rate at an upper bound of 5.50%.
As a surprise to almost everyone, Jerome Powell was not wearing a purple tie. In a month where the Fed’s statement reflected very little change since their last meeting, we have to find other details to cling to.
Here are a few details I find interesting — not only because of what they show in a chart, but because they’re two of the topics that seem to stoke the most debate among market participants around Fed meetings.
2% means 2%
In my opinion, Jerome Powell has been abundantly clear that the FOMC’s inflation target remains at 2% and they have not even considered changing it. Even so, there continues to be speculation that the inflation target will move up given current conditions, and some version of “this economy is different.”
There is also a temptation to point to the slope of inflation over the last 16 months as a reason to raise the target — we’ve made so much progress, let’s stop before we go too far.
But the Fed is tasked with maintaining stable prices, and if their definition of stable prices is 2%, they are not going to declare the end of the hiking cycle until we are on a “sustainable path toward 2%”. They obviously do not feel like that’s the case yet.
The chart above shows the four main measures of inflation, all of which are still 1-3 percentage points above target. None of this is an exact science, but reducing inflation takes time, and recent months have seen slower progress than the dropoff that followed last summer’s peak.
One of the things Powell said in the press conference was, “we’re committed to getting inflation back to our target over time, and we will.”
I choose to take him at his word. And to believe that two percent means two percent.
The Phillips Curve
This Phillips has no relation to Wilson Phillips, just to be clear. It’s also an economic theory that has absolutely not held on in this cycle.
The Phillips Curve shows the relationship between unemployment and inflation, with the expectation that as inflation falls, unemployment will rise. In other words, the two should move in opposite directions and have a negative correlation.
The conundrum for the Fed this cycle is that this relationship appears to be broken, and thus hasn’t been a useful tool in informing monetary policy decisions. Inflation has come down, but no one told the unemployment rate.
Needless to say, we don’t hear much about the Phillips Curve. If the Fed gets their way, and starts to see a period of below trend growth that is likely to inflict some pain on households and the labor market, we may see a revival in mentions of the Phillips Curve. Which means I expect an uptick in the unemployment rate as a result of this tightening cycle.
I also expect that around that same time, we’ll stop hearing people say “this time is different.”
I agree that this economy has a different makeup than it did when many economic theories were formulated — we’ve shifted from manufacturing-led to services-led growth with technology playing a major part in every sector, while also being the largest sector by weight in the S&P 500.
But the sector with the most names in the S&P 500 is still Industrials, and the sector with the second most names in the index is Financials. Meanwhile, Tech is tied for third with Health Care. I point that out because regardless of the weight a sector has in the stock market, it almost certainly has a different weight in the labor market.
We hear all the time that the stock market is not the economy, and that remains true. But if we’re looking at the possibility of rising unemployment and slowing growth, the stock market can’t entirely look away.
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