At the start of the year, there was little doubt that tighter monetary policy from the Fed was needed to cool an overheated economy and bring overwhelming demand closer to supply.
But in talking to many business leaders, it seems clear that not only the leading economic indicators from industry sources of all the main drivers of inflation (housing, labor, fuel and food) now suggest that inflation may have reached to the max, but also to be broad economic evidence that the Fed could already be on its way to slaying the inflation dragon even without continued rate hikes. Because the Fed generally relies on trailing indicators rather than leading indicators, our forward readings suggest that the Fed may be at risk of oversteer into a freeway skid if it continues to push further into the territory.” restrictive”.
On the housing side, a lot of attention has been focused on August’s “high” CPI of an annualized housing inflation of 9%. But this delayed measure may already be outdated. The housing CPI is naturally lagged as it captures all leases, although most are not renewed in a given month, so it takes time for the new price declines to leases are fully reflected in the CPI readings. This is in addition to a design flaw in the survey that the BLS, the compiler of the CPI, uses for CPI housing that is mechanically accumulated with a lag of a few more months.
Looking forward rather than backward, the key drivers of rising house prices and rents have largely reversed. Mortgage rates have doubled to 7% since the start of the year, while housing demand measured from prospective indicators through surveys, mortgage applications, volumes of sales and more has dropped significantly.
Lennar, the homebuilder on whose board I sit, has already identified several major metro areas such as Philadelphia, Reno, Boise and Utah where prohibitively high rates have led to a slowdown in activity despite a structural supply deficit of homes Lennar is tripling incentives from price cuts to aggressive mortgage rewards to stave off an expected 10% drop in orders in fiscal 2023. High cancellation rates among competitors suggest housing already has cooled significantly, although it is not yet fully reflected in the subsequent statistics, although they are. catching. Just yesterday, the Case-Shiller home price index developed by Yale colleague Robert Shiller posted its first monthly decline since the financial crisis.
In the labor market, a material supply-demand imbalance was widely recognized in the labor market entering the year driving “hiring skills” and wage growth. In response, the Fed has prioritized containing wage inflationary pressures, with several Fed governors on the record as predicting that the current unemployment rate may need to nearly double to restore job demand in line with the offer.
The Fed’s preoccupation with creating a glut in the labor market reflects an outdated Phillips curve mentality, even though there hasn’t been an inverse relationship between unemployment and inflation for at least thirty years, as many economists have pointed out, including President Powell himself before the pandemic.
What is far more relevant than the Phillips curve is that labor statistics are a lagging indicator, and certainly the labor shortage could moderate before it becomes apparent in the statistical readings.
In fact, anecdotal hiring data from companies suggests higher labor force participation rates as people become more comfortable returning to work after COVID, in addition to more hiring demand companies normalized after a rash of hiring to return to normal staffing levels in the wake of COVID. .
As Uber CEO Dara Khosrowshahi said on his recent earnings call, “when we look at the labor supply, the supply situation continues to improve, where the number of new drivers signing up in the U.S. it was up 76% in a year … year-over-year basis. So we have a very strong flow of new drivers who are signing up, who are getting to earn.” The chief executive of HCA Healthcare, a leading hospital chain, said that “we see the labor market moderating and normalizing”, characterizing easier hiring across the services sector.
Jeffrey Sonnenfeld – Steven Tian
The increase in labor availability reflects not only the return of lost workers, but also the recent increase in the supply of highly trained and educated immigrant labor through elevated H1B visas, a solution for which many leading business leaders, including Greg Fleming of Rockefeller Capital Management, have long advocated. This trend will continue to increase the number of skilled workers ready to fill specialized jobs in the coming months and years without the need to decrease demand.
And while some like Jim Cramer are quick to point to continued inflationary wage pressures, inflation has in fact far outpaced nominal wage increases. Real average hourly wages in the US have fallen by 2.8% over the past 12 months.
For fuel, as our research has shown, the story is one of increasing supply and decreasing global demand, although the supply story gets little attention amid bean balls launched against the energy policy of the Biden administration.
The US is already on track to approach, if not surpass, record crude oil production levels of around 12 million barrels per day (bpd). Another expected increase of 1 million bpd over the next year will obliterate the current record of 12.3 million bpd set in 2019.
Despite attacks on federal land-use and drilling permits, the total number of active U.S. oil rigs has nearly doubled from last year in all major domestic producing basins, more than offsetting small cuts in supply of the OPEC+ cartel.
Also, aware of the oil supply constraint, US Treasury policymakers intentionally designed sanctions to keep Russian oil flowing to global markets, preventing the loss of up to 7 million bpd from Russia.
With oil prices already back to pre-2022 levels and futures markets trading for even cheaper oil going forward, increased oil supply should fully offset the recovery in global demand without the need for no destruction of additional demand by the Fed.
Courtesy of Jeffrey Sonnenfeld and Steven Tian.
Similarly, US domestic natural gas production has soared to nearly 100 billion cubic feet per day (100 bcf/d), nearly 10 bcf/d more than last year, and the US maintains access to the cheapest gas flow of any country in the country. world with prices continuing to drop day by day.
The story is similar for food, as initial drought and supply fears gave way to record crop yields in major row crop producing nations including the US, China, Australia and even Ukraine. Indeed, even if no grain from Ukraine is able to reach the port, global grain supplies continue to rise year after year thanks to these record crop yields, an outcome that few thought possible just a few months ago, leading to a quick price declines across the entire agricultural complex, from grains to poultry and beef.
Even beyond fuel and food, as President Powell himself acknowledged, prices appear to have peaked across the commodity complex, from nickel and aluminum to lumber and cotton, in as we move out of the classic supplier market and into buyers’ markets through all of these crucial raw inputs. the global economy, with the help of the strongest dollar in recent years.
Commodity deflation, too, takes time to feed into supply chains and thus CPI and PCE inflation readings. As General Motors CEO Mary Barra said on her recent earnings call, “we are encouraged to see some moderation in spot prices for certain commodities, but the timing of that benefit to earnings it varies by commodity and is typically delayed. We don’t expect to see a significant impact until later this year and into 2023.”
Forward-looking financial markets have been valuing a return to 2% inflation across the yield curve through the breakeven points of market implied inflation even before Powell’s speech.
Courtesy of Jeffrey Sonnenfeld and Steven Tian
Of course, we agree with George Santayana’s wisdom that “those who do not remember the past are doomed to repeat it.” However, immersed in retrospective data, Fed officials should not confuse the past with the present, let alone the future.
Ultimately, central banks use the blunt tool of interest rates to drive the economy like “a good driver drives a car, with gentle applications of the gas and brakes to produce stability rather than slamming on the gas and then hit the brakes hard, causing it to move back and forth,” as investor Ray Dalio says. With leading indicators of housing, labor, fuel and food inflation showing calming inflation, the Fed risks oversteer into a freeway skid by going deeper into a “restrictive” territory.
Jeffrey Sonnenfeld is the Lester Crown Professor of Management Practice and Senior Associate Dean at the Yale School of Management. Steven Tian is the director of research at the Yale Chief Executive Leadership Institute.
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