Next Monday, I once again get to lace up my shoes and join my friends from the Dana-Farber team in running the Boston Marathon. This year will be particularly special, as both of our sons are also running the race.
One of the advantages of being an older member of the team, (and I can testify to plenty of disadvantages), is that you accumulate advice that you can share with younger members, particularly those who are running their first marathon. One such piece of advice is to drink before you are thirsty and eat before you are hungry.
By the time you are thirsty, when running a marathon, you are likely severely dehydrated and low on electrolytes, causing, at best, a sharp deterioration of your performance. By the time you are hungry, your blood sugar will probably be too low, making the rest of the race slow and painful. In short, in long-distance running, one key is to make decisions before it feels like you need too.
The same could be said for the management of monetary policy. Clearly, last Friday’s jobs report indicates that the economy has plenty of momentum while this week’s CPI report could show a minor rebound in year-over-year headline inflation. This could prompt a reprise of the “what’s the rush?” chorus from Fed officials and others. However, monetary policy is clearly in a restrictive zone, in an economy that doesn’t seem to need active monetary policy in either direction. This is not a great idea in general because of the distorting effect of active monetary policy on financial markets. Moreover, if the economy falters in the coming quarters, either of its own volition or because of some external shock, the Fed may feel compelled to cut very aggressively, given today’s relatively high short-term rates, in a manner that could actually further slow the economy, rather than helping it expand.
The Jobs Report
The March jobs report provided fresh evidence of momentum in the U.S. economy. Payroll employment rose by 303,000, well above the consensus forecast of 200,000, while the unemployment rate edged down to 3.8% - the 28th consecutive month with unemployment at or below 4%. Wage growth also continues to moderate, with average hourly earnings rising 4.1% from March 2023, its smallest year-over-year gain since June 2021.
This is a remarkable performance given the Census Bureau’s trend projections of just a 20,000 person per month increase in the working age population[1]. Given this forecast of very slow growth in the pool of potential workers, payroll job gains, which have averaged 244,000 per month over the past year, might well have been expected to drive the unemployment rate lower and wage growth higher, putting a quick end to the “soft landing”.
One reason the U.S. economy has avoided this fate has been surging labor force participation. At first glance, this surge isn’t obvious. While the overall labor force participation rate, for those aged 16 and older, edged up to 62.7% in March from 62.5% in February, it remains well below its 2019 average of 63.1%. However, this is entirely due to a change in the age mix of the population. We estimate that the seasonally adjusted labor force participation rate, for those aged 18 to 64, rose to 77.3% in March, its highest level in over 15 years and well above its 2019 average of 76.4%.
However, an even bigger reason for surging labor supply has been migration. According to the March jobs report, more than 100% of the gains in employment and labor force over the past year have come from people who were not born in the United States, with the native-born workforce actually shrinking. It should be recognized that these numbers are not precise, since the Labor Department very likely underestimated both immigration and population growth over the past year.
However, the general point stands based on other data, with over 2 million initial applications for employment approved by the immigration and naturalization service in fiscal 2023, up from a record 1.2 million in the prior fiscal year. Nor is the immigration surge slowing. In the first five months of the current fiscal year, that is the five months ended in February 2024, estimated encounters between border control agents and migrants at the southern border rose by 11% year-over-year while immigrant visas issued at foreign U.S. facilities climbed by 6%. This surge of migration is flooding the low end of the labor market, simultaneously boosting employment and slowing wage growth.
The CPI Report
This week, attention will be focused on Wednesday’s CPI report. We estimate that overall CPI may have risen by 0.3% to 3.4% year-over-year, with core CPI climbing 0.2% to 3.6% year-over-year.
The headline numbers will be boosted by energy prices, with the cost of a barrel of West Texas Intermediate Crude (WTI) rising from $77.25 in February to $81.28 in March. Moreover, with WTI closing at $86.73 on Friday, it looks likely that energy prices will also be up in the April CPI report. The recent rise in oil prices likely reflects supply disruptions and fears of supply disruptions due to the Ukraine war and escalating tensions in the Middle-East. However, it is important to note that it is not due to any surge in global economic activity, as witnessed by the still sluggish, although improving, global composite PMI index released last week.
Other measures of inflation look mixed, with rising inventories of new and used vehicles exerting downward pressure on prices, and global supply chains broadly looking balanced. Airfares and tobacco prices rose sharply in February and may have risen less in March. However, the most important short-term issue in inflation is the behavior of housing and auto insurance costs, categories that accounted for 84% of the 3.2% year-over-year CPI gain seen in February. We expect both of these areas to see slowing inflation in the months ahead, allowing core CPI to continue to drift down, with the Fed’s favorite measure of inflation, the core consumption deflator, seeing year-over-year growth fall from 2.8% in February to 2.6% in April and 2.4% by September.
No Right Time to be in the Wrong Place
This should be just enough to keep the Fed on track to start cutting rates in June and to provide three quarter-point reductions in the federal funds rate by the end of the year. As of Friday, the Fed Funds futures market was pricing in a 64% chance of the former and an 84% shot of the latter.
However, both of these forecasts are now a very close call. Even one upside surprise on inflation, in the March, April or May CPI reports, might be enough to make the Fed delay. Moreover, even if the data come in as we expect, it will be hard for the Fed to achieve consensus on a June rate cut. In the March summary of economy projections, while nine participants thought three rate cuts would be appropriate for 2024 and one was looking for four rate cuts, five thought there should only be two cuts, two wanted just one cut and two felt there should be no cuts at all.
In a recent on-stage interview[2], Jay Powell stressed the importance of the Fed achieving consensus if it could, and noted that, before every FOMC meeting, he actually has a scheduled call with each individual member of the committee. In preparing for the June meeting, provided inflation is still on a very slow downward path, he may well use these calls to gently nudge the committee into a first rate cut.
If this transpires, his strongest argument will be the value in normalizing policy before the data say that it is necessary. There is little evidence that cutting rates by a small amount from an elevated level would have any effect in boosting demand. However, there is plenty of evidence that large cuts from elevated levels don’t work well as they undermine consumer and business confidence while generally tempting borrowers to delay borrowing in the hope of being able to borrow at even lower rates in the near future.
On balance, then, it still looks like the Fed would be wise to get going on rate cuts in June, in line with its current schedule. Whether they do so or not, however, will depend on monthly inflation numbers and particularly CPI numbers in the near term. The eclipse won’t be the only focus of attention in the week ahead.
[1] In its latest population projections, published last November, the Census Bureau estimated that the population aged 18-64 would rise by just 242,000 between July 1, 2023 and July 1, 2024.
[2] March 29th interview with Kai Ryssdal of Marketplace radio, Federal Reserve of San Francisco Conference.