A weaker economy might mean lower rates, but only if it brings recession and falling profits - also bad for stocks. On this bearish view, a stronger economy means higher rates for longer, which is bad for stocks. That means underlying prices will keep rising too fast, and the Fed won't risk cutting rates - unless there is a recession. Sure, some of the prices that soared amid pandemic shortages, such as used cars, will fall back to earth, but overall demand in the economy is running ahead of supply. The bear case is that much of this is just noise in the data. Yet wage costs in leisure and hospitality, which ought to be most affected by the postpandemic demand to party and also most directly feed through into prices, rose more slowly than in private business as a whole in the fourth quarter. Strip out rent from services, and prices were up 4.9% on an annualized basis in December - a monthly rise surpassed only twice between the 2008-09 recession and the start of the pandemic. Powell still sees inflation danger in core services, where prices are particularly sensitive to higher wages. It is true that headline inflation is being dragged down by falling energy prices, and goods prices are coming down as postpandemic demand returns to normal. However, he has reiterated that the strong jobs market means rates will have to be higher for longer, a message the bond market has started to absorb but stocks seem to be ignoring. Goldilocks says to go ahead and buy stocks.įed Chairman Jerome Powell has stopped challenging the bulls, twice in the past week choosing not to push back hard against the recent stock-market rally. The Fed will realize that it doesn't need to be hawkish and rates will come down without unemployment needing to rise much, if at all. The bull case is that inflation was, after all, transitory. And wages are rising more slowly, with private-sector wage costs up an annualized 4.2% in the final quarter of last year, sharply below a 6.5% increase in the second quarter and not much above the 3%-4% compatible with the Fed's inflation target. Inflation is down, with the Fed's preferred measure running at an annualized three-month rate of 2.9% in December, from 6.7% in June. The unemployment rate was last lower in 1953. Last month's payrolls figures showed strong job creation, even stripping out the end of some public-sector strikes. The puzzle comes from the mix of three lots of data. At the very least, those of us who worried that the market was ahead of itself in preparing for a soft landing need to revisit our assumptions. Perhaps the Federal Reserve has it all wrong, and investors are right to be pricing in both lower rates later this year and a decent economy, as wage growth moderates and inflation falls. To the delight of investors, Goldilocks seems to be back, in spite of full employment that ought to push up wages fast. What investors really liked in the 1990s was a Goldilocks economy - not too hot, not too cold, just like the porridge she eats in the fairy tale.
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