By Dr. Charles Lieberman, Co-founder & Chief Investment Officer
Solid job numbers support the public comments of many Federal Reserve officials, who have been warning that that the market’s expectations for rate reductions in 2023 are unlikely to be realized. Inflation must slow decisively for the Fed to be comfortable reducing rates. We suspect that another 125 basis points in hikes will be implemented this year and quite possibly another 25 to 50 early next year before the Fed pauses to judge how much its policy actions have accomplished.
Job growth of 264,000 remains well above a sustainable pace. With the pool of unemployed at 5.8 million, September’s pace of hiring would empty the pool completely in less than 22 months. That won’t happen, of course. Hiring will slow even more than it already has as workers become ever scarcer. The unemployment rate reverted to its cycle low of 3.5%, so the job market is unambiguously tight. The reported decline in job openings certainly helps, but it has much further to go. In the meantime, firms struggle to find workers, driving up wage costs. The huge rise in labor force participation reported for August of 786,000 was only modestly reversed in September by a decline of just 57,000 and we anticipate little increase over the coming months. So, labor scarcity will persist.
It will take time for the Fed to get closer to its policy objectives, namely modest job growth of less than 50,000 per month that loosens the labor market and enables inflation to moderate. It is doubtful inflation will fall below 4% in 2023, even allowing for all of the transitory price increases to dissipate, so it would be premature for the Fed to ease up. But forecasting is hard, especially when we are trying to forecast the future, so it would not be surprising at all if the Fed paused its rate hikes to judge how much progress it has made towards its objectives. Additional rate hikes of 25 basis points may be implemented in early 2023 so that policy is somewhat restrictive before the Fed hits the pause button.
Markets have leapt well ahead of the Fed anticipating rate reductions in 2023. Since such expectations make it more difficult for the Fed to achieve its objectives, it is important for the Fed to dispel such ideas, hence the comments by senior officials, including most of the people who are considered doves.
The Fed is most certainly not trying to cause a recession. While a recession would surely bring down inflation, it isn’t a precondition to bring inflation back to 2%. The Fed prefers very weak growth that allows inflation to moderate without the full hardship of a recession. But such an outcome requires exceptional policy finesse, which is very hard to achieve with the blunt tools of monetary policy. That’s why we think a mild recession is the most likely outcome next year. Housing shortages and the return of manufacturing back home, reopening in China and rebuilding in Europe will limit the scope for an economic downdraft.
Like the Fed, all of our judgments are data dependent. There is plenty of opportunity for surprises and we must be prepared to adapt to the incoming information. But the stock market’s retrenchment has already created some really attractive opportunities. Trying to catch the bottom requires extreme luck, rather than outstanding skill. It remains our judgment that it is far too late to sell even if it is (perhaps) too early to buy. But since we see limited additional downside from current levels, we think nibbling into the outstanding values available or starting a buying program makes lots of sense. We remain defensive with respect to our fixed income holdings. In fact, the rise in rates enables us to be defensive and still earn attractive yields.
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