by Riccardo Sorrentino
In the face of very rapid rate hikes, financial conditions are still expansive: the markets have underestimated the determination of central bankers
3′ of reading
Break? Markets are quite convinced that the Federal Reserve will not hike rates at its June meeting. Indeed, the US central bank has an opportunity to seize. He can warn the markets of the need for a lasting and possibly even more incisive monetary tightening, through the projections for the second quarter: in June he had imagined bringing the official cost of credit to 5-5.25%, the current level, and to be able to drop to around 4.25% at the end of 2024. Any deviation from this path could signal the intention to tighten further, leaving however time to verify what is really happening on the markets and in the real economy.
Financial conditions still expansive?
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In fact, something is not going right. Data on prices, which also point to core inflation higher than overall inflation, are currently not very significant everywhere. Not only because they refer to the past: a purely “arithmetic” effect dominates, the base effect, which reduces annual growth rates (last year the indices were already rapidly running and very high). It will be necessary to wait for this phenomenon to subside . However, financial conditions, measured by the Chicago index – which summarizes more than one hundred indicators along the entire monetary policy transmission belt – are still in expansionary territory, and cannot exceed zero which, by definition, indicates neutral financial conditions .
Markets up again
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It is no surprise, of course, that monetary policy takes effect over a long and variable time frame. Fed Chairman Jerome Powell has made this point several times. In the United States, as elsewhere, however, the issue seems a bit more complex: the markets have not fully understood the intentions of the central banks. Long-term expectations remain anchored – even if one-year expectations remain above 4% – but the desire to bring inflation back to 2% is interpreted as an intention conditioned by the achievement of two other objectives: financial stability and a soft landing. The Whilshire 5000 index, the most observed by the Fed because it is the most complete, has “corrected” for the excesses of the past, but has returned to a long-term path (a trivial linear trend is even more precise than a loess), oriented towards a harrowing rise.
The decline in house prices has stopped
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Even the trend in the price of houses, although the data is stationary in March, marks a very timid trend reversal compared to a slightly more pronounced decline. The sector is rather sensitive to interest rate trends and one would expect a more prompt response from real estate prices to increases.
Labor market still robust
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The Fed obviously places a lot of emphasis on employment as well. In a phase of high inflation, a bright labor market paradoxically becomes a negative sign. In this phase, moreover, reading the data is complicated by the coexistence of factors not linked to the simple cyclical play of supply and demand, but to elements of a structural nature, such as the different preferences of workers. The shortage, on the supply side, of some skills – even “unsuspected” skills such as truck drivers and bricklayers – pushes wages up even in the absence of greater demand. How much of these phenomena can be attacked by monetary policy is difficult to understand. Employment is still robust, and shows no signs of slowing down.
Wages are constantly growing
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Hourly wages, amid still excess savings, generous fiscal policy and structural labor market trends, are still growing rapidly, faster than inflation and productivity. The slowdown compared to the recent past is evident – a sign that the bite of higher prices and the crisis is felt – but the pace remains high compared to a long-term average of 3%.
A mistake by the markets or a mistake by the Fed?
The risk is then that the efforts made so far by the Federal Reserve are not sufficient. It is a risk that brings out two hypotheses. The first, based on the performance of quotations, is that of a technical error: the decision to renounce forward guidance has led to an underestimation by the markets of the real determination of the Fed. The second, which looks rather at the economy real, is that of political error: the Fed is less determined than it should be, worried about financial stability and the economic slowdown. Rate projections, Powell’s words will be as important as they rarely have been in the past, in this situation.
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Richard Sorrentino
Editor
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