A couple of days ago, the Federal Reserve Chair Jerome Powell made a speech on the labor market and inflation. In it he signaled that the Fed would slow down or in his words, moderate the pace of their interest rate increases. The market responded really positively to the news with the Dow Jones jumping over 700 points in a single day. Making the index go back into a bull market, which is defined as a 20% rise from a recent low.
Let’s go over the key points of what Jerome Powell went over in his Wednesday speech as well as go over the new jobs report which was just released on Friday 2 November. From here on out, what it all means for interest rates, the market, and how it will affect everyone.
Latest FED talk
The Federal Reserve Open Market Committee meets eight times a year where they actually talked about the economy and monetary policy in the past four meetings. They’ve actually raised the interest rate point by 75 basis points. These are the largest rate increases that we’ve seen in a while in response to trying to tample down inflation that’s going on in the US.
Now, the next FOMC meeting is actually going to be held on December 13, and 14th. And what’s really interesting about that is that the CPI report for the previous month’s inflation is going to come out that day as well in Jerome Powell’s speech on Wednesday. This week, he actually went over how the Fed’s US inflation and he said that quote, to assess what it will take to get inflation down, it’s useful to break down core inflation into three component categories.
Number one is core goods inflation. Number two is housing services inflation. And finally number three is inflation in core services other than housing. So let’s go over each one and how each one is going in the economy right now.
When it came to core goods inflation, Jerome actually noted that it’s moving downwards. With supply chain problems easing and the prices of fuel and nonimport fuel prices have been going down. So that’s a pretty good thing. He said, Well, core goods inflation remains at 4.6%. That’s nearly three percentage points from earlier this year.
So in terms of court visitation, that’s a good sign when it came to housing services inflation that actually measures rents that actually have continued to rise, but that usually tends to lag slightly because people are still stuck in leases from the year prior.
Now leases don’t really turn over that quickly. So let’s pretend you’re leasing a place you’re in on 6 out of 12. And so it’s really hard for you to tell if new leases are going forward or cheaper than the year before. So that’s the metric that the Fed looks at, which is new lease signings. According to them, it’s actually been falling sharply since about the middle of this year. So housing services inflation is probably flat or neutral this year.
Core Service Inflation
The third component of this core inflation that Jerome Powell was talking about is actually the core services other than housing inflation. This covers services like health care and haircuts and hospitality to name a few. And now since this is actually the largest of the three categories. It’s going to have the highest impact on the overall inflation that the Fed is paying attention to.
Now, within this category wages is the biggest part of this entire category. So let’s pretend that you’re getting a haircut. Well, the person that’s cutting your hair actually needs to make more money. They’re able to make more money right now because there’s more of a demand for jobs. So because workers are in demand, they can actually command higher wages.
Jerome actually confirmed this and said, quote, the biggest remaining barrier to attaining inflation is the shortage of workers. Which is giving Americans the ability to seek higher pay. In essence, what he’s trying to say is right now there are just way too many jobs available. And to top it off, not enough workers are willing to fill those jobs. And so those workers get a lot of leverage.
Over the summer, there were actually two jobs available for every person looking for work. However, now that has actually dropped to about 1.7. According to the Fed, that is a good sign. But the Fed wants to see more of that rebalance and some wage growth is good. According to Jerome Powell, he mentioned that he needs to see wage growth to be closer to the target inflation rate of 2%.
So the summary of the speech was at the Fed is still really uncertain of what’s going to happen in the coming months. They are slowing down a little bit but in an effort to not overcorrect. He said that he’s going to be more moderate in raising interest rates. Investors right now are pricing in a 50 basis point hike compared to the point seven 5% that we’re expecting. So this is the newest stance that the Fed is having until December 13, and print of the CPI and that’s what’s really going to be the total sign here. So as long as the CPI print in December shows a trend of falling inflation or perhaps even flat inflation, then the market should respond pretty positively.
What to Expect in 2023
Now in terms of next year’s rate hikes in 2023. The strategy remains roughly the same for the Fed and Jerome Powell actually said in his speech quote, for starters, we need to raise interest rates to a level that is efficiently restrictive to return inflation to 2%. And despite the promising developments so far, we still have a really long way to go.
Economists actually see a recession in the next couple of months as pretty likely and Jerome has said that a soft landing is still possible, but it would likely depend on the dominoes falling in the right order, starting with a CPI reading in December trending in the right direction.
Lower Wage Growth
In the recent jobs report, it was reported that there were 263,000 jobs added to the US economy in November and this headline was interpreted by traders that the job market is still open to strong and that job growth is higher than the pre-pandemic average tech companies did a lot of layoffs in November but in other sectors of the economy many jobs were added in the leisure and hospitality sector.
80,000 jobs were added back so that means about 88% of all jobs that were lost during the pandemic in 2020. At that construction employment increased by 20,000. And manufacturing increased by 14,000 jobs. But again, remember the Fed cares about wages when it comes to inflation and interest rates. In terms of wages, the nominal average hourly earnings grew 5.1% In November, which is still a little bit too high.
According to the Fed, the Fed would like to see a couple of percentage points lower since the inflation report doesn’t come out until December 13. We won’t know what the real wages are until that report comes out.
Even though the headline was that the employment report was above expectations in terms of job growth. Job growth over the past three months has averaged 272,000 and is at least trending in the right direction, especially compared to 2021. So the Dow ended up 34 points, the S&P was down about five points, and NASDAQ was down about 21 points. It was pretty flat overall today.
Less investment worthy assets
Now as we are in a rising interest rate environment. What we’re going to see is we’ll start to see money moves out of equities and real estate and into other types of investments such as bonds. In fact, we’ve already kind of already seen this happening this year. This makes sense because if you can get a risk-free return of 4 to 5% on a government-backed bond that becomes pretty attractive to you and then stocks that have inherent risk become less attractive to you.
Warren Buffett has actually described interest rate traits like gravity so when interest rates are closer to zero investor’s pension and endowment funds aren’t really getting returned in bonds. So what do they do? They shift all of their money into equities which means the prices of stocks and valuations increase.
Now the opposite is also true as well. So when interest rates are really high, that means the gravity is really high and money starts to flow out of equities and into safer investments. You should still keep them in mind because going into 2023. We’re still gonna see the Fed increasing their interest rates throughout the first half.
What I am Doing
Personally since I’m super invested for the long term, I’m going to continue dollar cost averaging into my largest holding which is an index fund and if you’re a long term investor dollar cost averaging really helps you take the emotion out of investing. I feel like the more of a robot that I can be when it comes to investing, the better it is for me so that way just doesn’t panic.
Whenever the market goes down in terms of real estate, the rising of interest rates has actually increased the average 30-year fixed mortgage rate up to 6.49%. As of right now and it’s becoming even more expensive to afford a home these days go for.com has predicted that the mortgage rates will average 7.4% in 2023 with a 7.1% year and baseline prediction.
That means that existing home sales will drop by about 14.1% compared to the previous year and we may see some pain in the housing market. According to a recent report quote, home prices fell in every one of the top 20 US cities from August to September both the stock market real estate and even other things like bonds are going to be affected by the interest rate increases. So it’s really important that we keep up to date with what the Fed is doing especially in their next coming meeting in about two weeks.
So I’m really curious about what you guys think of this. Do you think that inflation is going to run rampant even further in December and January? Or do you think it’s actually going to come down and the markets are going to react positively personally I think the Fed is going to raise interest rates into 2023 until they see a trend that inflation is falling downwards for at least three to four months? So that might not even be until the end of 2023 or even into the year 2024?