Economic strength is forcing the Fed to become more aggressive
On Tuesday, we learned that a record 11.5 million jobs had been created by US employers as of March. This is a clear sign that the economy is booming, as it is not cheap to hire workers and most employers do this only when they do not have the staff to meet the demand.
Currently, only 5.9 million people are unemployed. In other words, there are almost two job opportunities for every unemployed person. The mismatch means that workers have a lot of options, which means they have a lot of advantages to demand higher wages. Indeed, employers are paying at historic rates.
But is rising demand, record job openings and higher wages… bad?
The Federal Reserve and a lot of people in the economics business do not state it so clearly. But this is their message effectively.
Status of the game: Demand for goods and services is significantly higher than supply, with 1G inflation sending higher rates for decades. This is partly due to the fact that higher wages mean higher costs for businesses, many of which are raising prices to sustain profits. Funnily enough, these higher wages have helped strengthen the already-strong finances of consumers, who are willing to pay and thus enable businesses to keep raising prices.
It is important to note that this growing demand is driven by job creation (that is, the tendency for a person to go from earning nothing to earning something). In fact, the US has created 2.1 million jobs so far in 2022.
The Bureau of Labor Statistics has a metric called the Total Weekly Wage Index, which is the product of jobs, wages and working hours. This is a rough proxy for the total nominal cost capability of employees. This metric was at 10% year-over-year in April and has been at 9.5% since April 2021. Before the epidemic, they were trending at about 5%.
This combination of job growth and wage growth is exacerbating the problem of inflation.
And so, at this stage, the best solution is to tighten economic policy to make the economic situation a little more challenging, so that demand can cool down, which can ease some of these persistent inflationary pressures.
In other words, the Fed is working to get away from some of the good news coming out of the economy because that good news is actually bad.2
Fed moves to trim ‘extra demand’
In a larger-than-expected move, the Fed on Wednesday raised the short-term interest rate by 50 basis points from 0.75% to 1.00%. This was the largest increase in a single announcement by the central bank since May 2000.
Furthermore, Fed Chair Jerome Powell indicated the intention of the Federal Open Market Committee (the Fed’s Committee on Monetary Policy) to keep hiking rates at an aggressive pace.
“Assuming the economic and financial situation is evolving as expected, there is a broad sense in the committee that an additional 50 basis points increase must be on the table in the next two meetings,” Powell said. “Our main focus is using our tools to bring inflation down to our 2% target.”
To be clear, the Fed is not trying to bring the economy into recession. Instead, it is trying to get more demand – as there are more employment opportunities than the unemployed – more on supply.
“There’s a lot of extra demand,” Powell said.
Currently, there are large financial tailwinds, including additional consumer savings and booming capex orders, which should boost economic growth for months, if not years. And so there is room for the economy to ease the pressure on demand without slowing down.
