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Top of Mind with SIFMA Insights: What to Look For at Jackson Hole

A Conversation with Katie Kolchin and Dr. Lindsey Piegza

In this episode of Top of Mind with SIFMA Insights, SIFMA’s Head of Research, Katie Kolchin, CFA, is joined by Dr. Lindsey Piegza, Chief Economist at Stifel and Chair of the SIFMA Economist Roundtable to discuss the status of inflation, the future for rate hikes, and what to look for at the Fed’s annual Economic Policy Symposium in Jackson Hole, kicking off on August 24.

Transcript

Edited for clarity

Katie Kolchin: Hello, and welcome to Top of Mind with SIFMA Insights. I am Katie Kolchin, SIFMA’s Head of Research. In this episode, we discuss the status of inflation, the future for rate hikes, and what to look for at the Fed’s Annual Economic Policy Symposium in Jackson Hole, kicking off on August 24th. I am excited to be joined by Dr. Lindsay Piegza, Chief Economist at Stifel, and Chair of the SIFMA Economist Roundtable. Thank you for joining us, Lindsay.

Dr. Lindsey Piegza: Thank you for having me, Katie.

Katie Kolchin: So let’s start with inflation. I’ll quickly remind our listeners where we stand across the various measures. The July reading for headline CPI actually tipped up 0.2 percentage points from the prior month to 3.3%. For core CPI, we came down 0.2 percentage points to 4.7. We have not had new data for PCE, which as a reminder to our listeners is the Fed’s preferred measure of inflation. Since the June reading, where PCE was 3.0% and core PCE was 4.1%, down 0.85 and 0.5 percentage points from the prior month respectively. As a reminder, the Fed’s target inflation rate is 2%. So while CPI is down 5.6 percentage points from its peak, an upward turn last month is not what the Fed was looking for. What was your take on the latest inflation data? Was the upward ticket an anomaly and do you believe it changes anything in the minds of FOMC voting members?

Dr. Lindsey Piegza: Well, I think it’s clear the latest inflation data is sending a somewhat mixed message. Now, investors seem to be focusing on the more positive aspects of the reports. The latest core CPI reading, as you mentioned in particular, now marking the slowest pace of ascent since October of 2021 as an indication the Fed should potentially take a second round pause in September and is evidence that price stability is nearly established. However, on a nominal basis at 4.7%, again, as you mentioned, core prices still remain more than double the Fed’s intended 2% target, with the rate of descent, meaning the pace of disinflation, disappointingly slow. Looking in the details, we see shelter costs still elevated, not to mention the recent reversal in at least monthly energy prices, both pushing headline inflation higher. This suggests there may be further commodity price pressures coming down the pipeline, potentially resulting in a further backup in costs come August, in the August report. So when we look at this from the perspective of Fed policy members, coupled with a recent backup in five-year inflation expectations reaching a 14-month high, now is not the time for the Fed to lose its resolve to continue with higher rates in order to ensure a return to stable prices. Policy officials have made great progress, lessening the pace of inflation from earlier peak levels back in June of last year. But remember, the goal is not to get inflation from up near 8% to under 5%, but to ensure a continued downward trajectory back to the 2% target level. So it’s clear there’s more work to be done.

Katie Kolchin: Interesting. So let’s move specifically to the labor side of inflation. The unemployment rate was 3.5% in July, stuck in this 3.4% to 3.7% range since March of 2022. Total non-farm payroll employment rose by 187,000 in July, less than the 312,000 we have averaged over the last 12 months. This was actually the second month in a row where this figure was in the 180,000s. Finally, average hourly earnings were plus 4.4% year of year in July, which is the average level we’ve seen throughout 2023. What are your thoughts on the labor market? What and how long could it take to see substantial, sustainable signs of cooling that could satisfy the Fed? What unemployment rate will we need to reach to register with the Fed? Or is it really more about a slowing in wage growth?

Dr. Lindsey Piegza: I would say yes. The labor market remains surprisingly resilient. But while still hiring, more recently businesses have needed or opted for fewer workers, indicating some signs of cooling and removing at least some of the elevated pressures on hiring costs. Now wages are still elevated, absolutely. But further upward momentum in labor costs is unlikely as the Fed continues to firm policy. That being said, then, significant downward pressure is equally unlikely until labor supply increases markedly or the demand for labor is sizably diminished as businesses may find technological alternatives or they themselves falter under eventually slowing economic conditions. The timeline for vast improvement or returning to a point of equilibrium could take some time.

Now, turning to the unemployment rate, yes, it does remain at a near multi-decade low, but in some part, that downward pressure appears to be artificial in nature, subdued due to sidelined workers. Now whether that’s due to lingering health concerns or a new outlook on the work-life balance, millions of potential workers are not actively participating in the labor force and by extension not included in the unemployment statistics. But nuances in the calculation aside, for the Fed, officials have been clear they’re not aiming to specifically raise the unemployment rate. That being said, the honest realization is that the committee is trying to slow the economy to tame inflation. And as a result then, at least some softening in labor market conditions should be expected and arguably welcome. So to answer your question, what will we need to see or likely see in terms of the unemployment rate? Well, at a minimum, I would expect a rise to about 4.7%, breaching the lower bound of what the Fed has determined is the full employment or the target range for unemployment in a stable inflationary environment.

Katie Kolchin: This is all very interesting, Lindsay. Now let’s shift to, let’s call it the other side of the rate conundrum. The rate hikes have been unprecedented, 525 basis points in around a year and a half, moving away from the Fed’s historical step function pattern to a very steep slope. Then in March of this year, we saw real impacts of monetary policy with the regional bank turmoil. I know economists have researched the lag time for monetary policy to reach the real economy. What do you estimate the historical lag time to be and what, if anything, do you see as different this cycle? And should we be concerned that, based on what we saw in March, something could crack?

Dr. Lindsey Piegza: Well, historically, Fed officials have assumed a sizable timeline between the implementation of monetary policy and the real effect on economic conditions in a range of about 6 to 12 months. However, more recently, many argue that the gap, that time differential, has been greatly diminished with a growing level of transparency in the policymaking process. So if you think about it, we now have a summary of economic projections, or a SEP, four times a year, a press conference at every meeting, not to mention ample commentary and Fed speak from a plethora of officials. So all of this has arguably led then to an anticipatory nature of financial market condition, meaning the Fed’s next move or moves are largely already priced into the market, often before they’re even made official because policymakers have been clear in the pathway for policy. They’ve communicated that ahead of time. Which is to say, if in fact there is a diminished period between action and the effect of Fed policy, well, the minimal impact of over 500 basis points, as you mentioned on prices so far, this should force the Fed’s hand to step back up to the plate sooner than later, likely with another rate hike, not a pause come September.

But in terms of breaking something, I think we have to put this in perspective of what the Fed is trying to do. Now, breaking may be a bit of an aggressive word, but the Fed is clearly trying to slow the economy. The Fed raises rates to tap down investment, tap down consumption, and by extension, top-line growth slows, resulting in more benign inflation. So that’s the intention of tight or tightening monetary policy. So in fact, the notion that things are cooling or slowing or breaking, shouldn’t deter the Fed but embolden officials that finally earlier policy initiatives are having the intended effect.

Katie Kolchin: Interesting. So let’s move on and talk more about rate hikes or pauses. The Fed paused at the June meeting and then raised another 25 basis points in July, which brings us to 5.25% to 5.50% for the Fed funds rate. First, we’d love to hear your thoughts on what drove the decisions at the last two meetings. Then moving forward, what are your expectations? Do you expect to see a continuation of the skip hike pattern and therefore pause in September?

Dr. Lindsey Piegza: Well, it’s a good question, a valid question, and I think it’s one that officials tried to preemptively and clearly address back in the June communication. According to the FOMC statement and Fed commentary after that, the temporary stay in policy in June was never intended as a prolonged adjustment in policy and never was it an indication that the committee judged price stability had been met. Rather, the temporary pause was simply intended to allow Fed officials to fully assess economic conditions that remain stronger than expected, yes, but that are still uneven, and in some cases losing ground. It also allowed the Fed time to better assess financial market conditions in the aftermath of the recent failures. So at that point in June, while the data didn’t specifically support even a temporary halt to rate hikes, the anticipation of potentially worsening conditions as a result of earlier policy action, coupled with uncertainty, particularly in the banking sector, warranted taking a breath.

Now more recently, as of July, the Fed affirmed a relatively solid assessment of economic and financial conditions. They noted in the July statement robust job gains, a modest economy, and a sound and stable banking system, all while the committee noted that inflation remains elevated. So it was very clear by the Fed’s assessment that the data justified re-engaging in July. Now going forward, that doesn’t mean the Fed will automatically revert to a predetermined or steady pace of hiking at every other meeting in that, as you mentioned, a skip re-engage pattern. In fact, if we listen to Chair Powell, he was very clear that consecutive meeting hikes are not off the table. On the other side, he also said that a longer span between rate hikes was not out of the realm of possibilities. But pace aside, I think it’s more important that we note the Fed is clearly not yet convinced it has reached a sufficiently restrictive level of policy to tame inflation back to 2%. So despite the market’s dismissal of a September rate hike, unless there is a massive deterioration in the next few weeks, the recent hotter-than-expected inflation reports should keep pressure on the Fed to raise rates another 25 basis points next month.

Katie Kolchin: Can you please remind us of what your expectation is for the terminal rate and when we could reach that level and then when you were forecasting rate cuts?

Dr. Lindsey Piegza: Well, Katie, as you know, and many of our listeners are aware, I have long been in the 6% camp with the Fed raising rates at least once, if not twice more by the end of the year. However, that being said, I would argue that total policy firming will be a reflection of the terminal rate, meaning any additional rate hikes, as well as an organic change to credit conditions. So at this point, it’s somewhat obvious that tighter lending standards are also likely to emerge and have already emerged in the aftermath of the recent bank failures. And just like higher rates, these more stringent standards work to tap down investment and consumption, eventually resulting in that slower growth rate and more benign price pressures. So the idea is that if tighter lending limitations help to do some of the Fed’s work, maybe 25 or 50 basis points, well, this would potentially reduce the peak level of rates needed. Maybe the fed funds doesn’t need to reach 6% if total policy firming, again, rate hikes and tighter credit conditions get us to a total policy firming near 6%. But yes, we do maintain that 6% is the minimum level needed by any combination to rein in inflation.

So that’s really the first question. How high? But, the second question is for how long? And as far as rate cuts are concerned, I don’t expect rate cuts for some time. Certainly not in 2023, but even 2024 remains very uncertain. Because keep in mind, even after the Fed has reached that sufficiently restrictive level to tame the demand side of inflation, there’s no guarantee that inflation will continue to fall if the supply side or other types of inflationary pressures keep prices higher. Remember, the Fed has no control over corporate or international policy. The Fed can’t broker peace between Russia and Ukraine, and the Fed certainly can’t print more ships. So the risk to inflation, in my mind, remains to the upside, suggesting the Fed, well, the Fed won’t need to raise rates indefinitely, but the risk is that the Fed will need to keep rates higher at that terminal level for much longer than I think the market is anticipating.

Katie Kolchin: Higher for longer then. You’ve stuck by that stance, Lindsey. You’ve been very consistent with that. So now let’s move on to what we need to listen for at Jackson Hole. This annual meeting is a good opportunity for market participants to get a read, or at least a perceived read, on what the Fed might do at the next FOMC meeting in September. What do you expect or are intensely looking to hear from Chair Powell? Do you foresee any surprises or more of the same rhetoric from the Chair?

Dr. Lindsey Piegza: Well, let me back up and put this in the context of the July rate hike. The decision to reengage was unanimous, but I think more broadly, there appears to be a growing divide among policy officials as to the current proximity to the terminal level of rates. Many officials, again, even those in favor of an 11th round hike last month, have suggested that much of the committee’s work has already been done with a trend of disinflation well established and early signs of cooling in the labor market. Others, however, are less convinced that an earlier painfully slow contraction from peak levels of prices will ensure further improvement. Questioning the notion of a linear extrapolation of what we’ve seen over the summer months as an indication of what’s to come, particularly given as we talked about the stubbornly elevated level of wage pressures, the resiliency in the consumer and broader economy, and more recently, a rise in commodity costs. So what will I be listening for? How will Fed officials respond in the face of an upturn or a meaningful upturn in inflation? Are officials even considering that scenario or is it just a matter of the pace of disinflation that the Fed is focused on? How does the Fed view the balance of risks between raising rates too high or slowing the economy too much against the need to reach its 2% goal? So I’m gonna be looking, listening very closely for any clues in terms of how the Fed may be answering any of these broader questions in terms of inflation and monetary policy.

Katie Kolchin: So before we close, if you had to pick one metric, or if that is too narrow, one specific area to watch, what do you believe is the most important to the Fed’s decision-making?

Dr. Lindsey Piegza: Well, aside from inflation, I’m going to say the consumer. Because the consumer is the backbone to the U.S. economy. If the consumer isn’t happy and healthy outspending in the marketplace, we can’t expect the broader economy to continue to fare well. The consumer has been surprisingly resilient, as we saw in the latest retail sales numbers, but there are many temporary factors. We’ve seen a drawdown in savings, a last sputtering of fiscal, state, and local support, debt forbearance, which wasn’t supposed to be forgiveness, ramping up credit card debt, tapping into 401ks. There are many factors that had aided that resiliency, which are now beginning to fade. So that’s not to say that the consumer is poised to fall off a cliff, but as these factors wane, so too will the strength of the consumer.

Katie Kolchin: Interesting. I think that’s a good place to stop and we can all look forward to Jackson Hole on August 24th through 26th. Thank you, Lindsay, for your insights.

Dr. Lindsey Piegza: Thank you very much for having me.

Katie Kolchin: As a reminder to listeners, prior to the June and December FOMC meetings, SIFMA Research publishes our economic survey with forecasts from the SIFMA Economist Roundtable on GDP, unemployment, inflation, interest rates, and more. We also review expectations for policy moves at the upcoming FOMC meeting and discuss key macroeconomic topics and how those factors impact monetary policy. This year, We launched flash polls to update our economist estimates after the March and September FOMC meetings. Please stay tuned for the September flash poll. To read our economist round table survey reports and other SIFMA Research reports, please enter SIFMA Research into your web browser. Thank you for listening.

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Katie Kolchin, CFA is Managing Director, Head of Research for SIFMA and the author of SIFMA Insights.

Dr. Lindsey Piegza is the Chief Economist for Stifel Financial and Chair of the SIFMA Economist Roundtable.

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