Illustration by Milan Kecman
There was absolutely no reason at all to be so grim about the inflation outlook. But the geriatric Jeremiahs at the Fed had already donned their hair shirts and were pushing up interest rates in earnest. And once again it looked like the battle was being fought along class lines - as if the greatest threat to the stability of the American way of life was having too many people gainfully employed.
Fed Chairman Alan Greenspan, locked in his own private torture chamber over the continued rapid gains in the stock market, even devised a new philosophy of economics to slow things down. This former champion of the new era economy decided to turn the handsome productivity gains that have made the entire miracle possible into a "reverse Martha Stewart." Instead of being a good, anti-inflationary development, higher productivity actually was giving rise to inflation by creating unsustainable demand.
It was a bad thing. A look at the Federal funds futures contract confirmed the market's growing suspicion that the Fed, currently embarked on a tightening cycle, would continue to lift interest rates anywhere from 25 to 200 basis points during the next year and a half.
He done a bad, bad thing!
Those 200 basis points would come on top of the 175 basis points of higher rates the Fed had already administered, the most recent of which had come in the form of a 50-basis-point hike on May 16th.
And then suddenly it was over. In the space of an hour or two all the future expectation of tightening was hammered flat out of the money market. The catalyst? The sudden and dramatic weakness of the May employment situation report, which, among other things, showed a decline of 116,000 in payrolls, a 0.2% increase in the unemployment rate to 4.1%, an extraordinarily muted wage gain of just 0.1% (bringing the 12-month moving average to a very well-behaved 3.5%), a healthy jump in the labor force, and a plunge in the diffusion index (it measures the number of industries gaining or losing jobs) to its lowest level since the last recession. In case you prefer the household survey of employment, it showed that 991,000 people lost their jobs in May.
If you froze cybertime, broke into the government data banks, and constructed an employment report that would remove any trace of further Fed tightening from money market desks across the globe, you couldn't have come up with a better report than the one released by the Bureau of Labor Statistics on Friday, June 2.
The way things regularly go, there is something - and more usually, several things - in a multi-faceted, pace-setting economic report like that on the monthly employment situation to arm both the hawks and doves with enough anecdotal and seasonal detail to argue a decent brief for their cause.
Not this time.
The data were so overwhelmingly weak that that phenomenon and that phenomenon alone was the only argument for refuting them. In light of everything else we know about employment, demand, and consumer confidence, the sudden and sharp deterioration in the employment situation makes no sense at all.
But, ah! Ignore that set of numbers at your own peril. Coming as it did on the heels of other signs of a slowdown - the third consecutive lower reading in the monthly purchasing managers' index, along with a 10-point drop in the critical pricing component; weakness in new and existing home sales, as well as construction put in place; a decline, albeit from a noble height, in car sales; and some weakness in chain store sales - it forces a hidebound Fed to the sidelines and renders a June tightening (heretofore a foregone conclusion) a less-than-even-money bet. Any additional rate hikes in the following months must also be considered a long shot.
How could one silly report do this, you ask?
Well, it's not just one silly report. What the report did was underscore the notion of the Fed as dinosaur - the Fed as an increasingly marginal institution bent on breaking the back of an expansion that continues to be both non-inflationary and non-threatening.
Whether or not there is a slowdown developing, there now is the widespread perception that a slowdown is developing, and that makes it very difficult for the Fed to tighten. It has to take a pass when it next convenes the Federal Open Market Committee, its policy-making arm, on June 27th, for nothing else than prudence's sake. Beyond that, it is normal for the Fed to take a pass in the meeting directly following the one in which they lift rates by 50 basis points, which they did when they met last month.
After that they start running out of time, and smack-dab into the election. Now it's not unheard of for the Fed to raise rates as polling time approaches - they did it in 1988. But they have administered 100 basis points of bitter medicine already this year and don't want to look like they're piling it on. August represents their last chance to tighten before the November election. I'm betting they'll take another pass then, too. Besides, as I have been saying for several years, there just isn't any inflation to speak of.
Because this group of silly old men still calls the shots, the rest of us are forced to take seriously developments and pronouncements that often make no sense.
As I looked over a report I wrote just ahead of the payroll release, I realized something I had overlooked in the course of sounding out a trend that the Fed would certainly not be pleased about.
Pricing power among small businesses has resurfaced in the first few months of the year. That and continued reports of modest but steady wage gains were certain to keep the Fed in a hostile mode, I concluded.
But what is most certainly different this time is that the pricing power among small and even large businesses is occurring amidst a backdrop of continued large productivity gains. There is no sign at all of "wage push" inflation. Indeed, if anything, this particular cycle could be referred to as a "wage pull" cycle. Wages rise only after prices move higher, and then only modestly.
This is a perfect environment for conducting commerce, and one that the Fed should leave unimpeded.
You can tell by the remarks of a number of Fed officials that their attitude has shifted appreciably. The hawks have gone from indefatigably banging the drum about the need for many more rate hikes to conceding some sort of slowdown. Of course, they require further proof. But at the very least they've been lifted from their tightening harness, making future Fed action, for the time being, a 50-50 proposition. This is no small beer in the land of skinflints and sadomonetarists.
I imagine the rally in techs and financial stocks will continue for quite a spell, particularly in the tech arena. NASDAQ should rally to new highs. As for the bond market, the yield curve will continue to compress, led by rallies in the longer-dated maturities, unless further signs of weakness manifest themselves.
That's highly unlikely because the economy is anything but weak. It is extraordinarily productive and growing apace with little inflation. And who can kick about that?