PrefBlog

Powell gave a speech:

Federal Reserve Chair Jerome Powell said on Tuesday the latest U.S. employment report showed the process for getting inflation back near the central bank’s 2 per cent target will take “quite a bit of time” even though there are indications cost pressures are ebbing, at least for goods.

The nonfarm payrolls report for January, which was published on Friday, was “certainly stronger than anyone I know expected,” Powell said during a question-and-answer session at the Economic Club of Washington.

“We didn’t expect it to be this strong,” Powell said, but it “shows why we think this will be a process that takes quite a bit of time.”

At the same time, Powell declined to equate the surprising strength in the job market shown in the January employment report with an expectation that interest rates would need to be higher than Fed officials estimated late last year.
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“I think it surprised all of us,” Minneapolis Fed President Neel Kashkari said in an interview broadcast on CNBC earlier on Tuesday, referring to the blowout jobs report last Friday in which the U.S. government reported a gain of more than half a million jobs for January.
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The numbers were far out of line with the looser labour market the Fed has expected and feels will be needed to ensure that wage growth also slows and inflation, which is still running at more than double the central bank target, continues to fall.

Kashkari, who has been more aggressive than almost all his colleagues in his assessment of how high interest rates need to go, had said a month ago that he forecast the central bank’s policy rate should rise to 5.4 per cent. The jobs report consolidated that view.

“It tells me that so far, we’re not seeing much of an imprint … on the labour market,” Kashkari said. “It’s pretty muted so far, so I haven’t seen anything yet to lower my rate path.”
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On Monday, Atlanta Fed President Raphael Bostic was one of those who said the central bank may need to lift borrowing costs higher than previously anticipated given the job gains. He noted that while a half-percentage-point rate hike was not his base case for the next policy meeting in March, it could be considered.

“It’ll probably mean we have to do a little more work,” Bostic told Bloomberg News. “And I would expect that that would translate into us raising interest rates more than I have projected right now.” Bostic had previously forecast that the federal funds rate would top out in the 5.00 per cent-5.25 per cent range, like almost all his colleagues.

Macklem also gave a speech:

Bank of Canada Governor Tiff Macklem said on Tuesday that he does not expect to continue raising interest rates, reinforcing that the central bank has entered a new phase in its year-long battle with inflation.
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“If new evidence begins to accumulate that inflation is not declining in line with our forecast, we are prepared to raise our policy rate further,” Mr. Macklem told a Quebec City audience on Tuesday, according to the English text of the speech. “But if new data are broadly in line with our forecast and inflation comes down as predicted, then we won’t need to raise rates further.”
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“Our preferred measures of core inflation have been stuck at about 5 per cent. But timelier three-month rates have come down below 5 per cent. That suggests core inflation will start to decline in the months ahead,” Mr. Macklem said.

The bank’s latest forecast shows the annual rate of inflation slowing to around 3 per cent by the middle of the year, and reaching 2.5 per cent by the fourth quarter.

The IMF published an excellent opinion piece, by which I mean I agree with it:

Decision-making procedures are also crucial to fostering individual accountability and mitigating the risk of groupthink. In the past, the phrase decision-making by consensus had largely positive connotations. However, modern organizational management recognizes that such practices tend to discourage innovative thinking and marginalize anyone with a different viewpoint (outside the consensus). Consequently, every MPC policy decision should be subject to a vote, and all MPC members should be held accountable for their own individual views.

In analyzing the inflationary episodes of the 1970s, one key lesson learned was that monetary policy decisions need to be insulated from political interference. Indeed, that lesson led to the strengthening of the central bank’s statutory independence in many jurisdictions—most notably, regulations ensuring that central bank officials cannot be terminated except for malfeasance. Such independence is enhanced by staggering the terms of MPC members, appointing each member to a single nonrenewable term, and ensuring that the appointment process is systematic and transparent rather than relying on the discretion of any single government official (Archer and Levin 2019).

MPC members should not be constrained to speak with one voice in their public communications; rather, they should be accountable for conveying their own individual views regarding complex judgments on which reasonable experts may disagree. To avoid cacophony, the MPC should follow the standard practice in the judicial system, where a panel of judges conveys each decision by issuing the ruling of the majority together with concurring opinions and dissenting views. Such an approach has a long track record of providing clarity about the rationale for the majority’s decision as well as the reasoning behind alternative views. Likewise, this mode of communicating monetary policy decisions can strengthen public confidence that decisions are being made by a diverse team of experts.

The New York Fed released the Global Supply Chain Pressure Index (GSCPI):

Estimates for January 2023

• Global supply chain pressures decreased moderately in January and the index was revised upward in December.
• The largest contributing factors to supply chain pressures were declines in Korean delivery times, Chinese delivery times, and Euro Area backlogs.
• The GSCPI’s recent movements suggest that the Asia developments that were interrupting the index’s normalization may have been a transitory factor.

Jobs, jobs, jobs!:

The American labor market unleashed a burst of hiring in January, producing another wave of robust job growth even as interest rates continue to rise.

Employers added 517,000 jobs on a seasonally adjusted basis, the Labor Department said on Friday, an increase from 260,000 in December.

The unemployment rate was 3.4 percent, the lowest since 1969.

Even as hiring surged, wage growth slowed slightly to 0.3 percent compared with December.
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In addition to the report on Friday, the government released data this week showing that the number of posted jobs per available unemployed worker — a measure that policymakers have been watching closely — rose again in December. And despite a cavalcade of layoffs in the technology sector, the overall number of pink slips has stayed extremely low.
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The job growth was broad-based, including in some industries that economists had expected to show signs of slowing. Employers in leisure and hospitality, including restaurants and bars, brought on a bevy of workers.

The labor force participation rate was unchanged at 62.4 percent. Fed officials have been hoping to see an increase in the ranks of those available to work, which could alleviate the tightness in the labor market that is driving up wages and contributing to inflation.
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Average hourly earnings climbed by 4.4 percent over the year, more than forecast in a Bloomberg survey of economists but less than 4.8 percent in December. Pay growth has been decelerating for months, though it remains faster than is typical and is still notably quicker than the pace that Fed officials have at times suggested would be consistent with their 2 percent inflation goal.

The Bank of England hiked 50bp yesterday:

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 1 February 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.5 percentage points, to 4%. Two members preferred to maintain Bank Rate at 3.5%.

Global consumer price inflation remains high, although it is likely to have peaked across many advanced economies, including in the United Kingdom. Wholesale gas prices have fallen recently and global supply chain disruption appears to have eased amid a slowing in global demand. Many central banks have continued to tighten monetary policy, although market pricing indicates reductions in policy rates further ahead.

UK domestic inflationary pressures have been firmer than expected. Both private sector regular pay growth and services CPI inflation have been notably higher than forecast in the November Monetary Policy Report. The labour market remains tight by historical standards, although it has started to loosen and some survey indicators of wage growth have eased, alongside a gradual decline in underlying output. Given the lags in monetary policy transmission, the increases in Bank Rate since December 2021 are expected to have an increasing impact on the economy in the coming quarters.
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In the latest modal forecast, conditioned on a market-implied path for Bank Rate that rises to around 4½% in mid-2023 and falls back to just over 3¼% in three years’ time, an increasing degree of economic slack, alongside falling external pressures, leads CPI inflation to decline to below the 2% target in the medium term. There are considerable uncertainties around this medium-term outlook, and the Committee continues to judge that the risks to inflation are skewed significantly to the upside.

The European Central Bank also hiked 50bp:

The Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target. Accordingly, the Governing Council today decided to raise the three key ECB interest rates by 50 basis points and it expects to raise them further. In view of the underlying inflation pressures, the Governing Council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy. Keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations. In any event, the Governing Council’s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.

The New York Fed has released a paper by Julian di Giovanni, Şebnem Kalemli-Özcan, Alvaro Silva, and Muhammed A. Yıldırım titled Quantifying the Inflationary Impact of Fiscal Stimulus under Supply Constraints:

This paper builds on Baqaee and Farhi (2022) and di Giovanni et al. (2022) to quantify the contribution of fiscal policy to U.S. inflation over the December 2019-June 2022 period. Model calibrations show that aggregate demand shocks explain roughly two-thirds of total model-based inflation, and that the fiscal stimulus contributed half or more of the total aggregate demand effect.
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U.S. headline inflation has hit levels not seen for several decades, reaching 9 percent per annum at its peak in June 2022, before declining to approximately 7 percent per annum by the end of 2022. In contrast, inflation was below 2 percent before the 2020 COVID-19 pandemic.

A priority that has been at the top of the minds of both policymakers and academics alike has been to quantify the relative importance of the key factors in driving the observed inflation, particularly the relative importance of supply bottlenecks vs. consumer demand, as the U.S. and world economies struggled with supply-demand imbalances arising from the COVID-19 health shock combined with stimulative policies.

The literature thus far has found differing results, ranging from one-third to two-thirds contributions from supply factors (with the remaining being demand). Shapiro (2022a,b) takes an econometric approach while di Giovanni et al. (2022) and Ferrante, Graves and Iacoviello (2022) use quantiative models.

Though these papers provide important early evidence on the different channels that drove the surge in inflation, none of them take a stand on the inflationary impact of specific policy actions. In particular, the 2021 Biden fiscal package totaled 15% of GDP and has been blamed by some for today’s high inflation (Blanchard, Domash and Summers, 2022).

The IMF has published a piece in defence of globalization:

Today’s surge in inflation grows out of the interplay of supply chain disruptions with large fiscal deficits. The pandemic, followed by Russia’s invasion of Ukraine, upended supply chains and produced scarcities. Rich industrial countries responded to the shortages, inequalities, and social stress with large fiscal packages. In the ensuing spiral, increased spending led to more demand, which led to more shortfalls. Another vicious spiral may follow. Rising food and fuel prices could spark discontent, protests, even revolutions and government breakdowns around the world.

The inflationary spiral may appear to herald a quite different world, split into competing blocs that pursue costly “friendshoring” strategies of steering trade to friendly nations and regimes while attempting to hobble rivals. Large states rethink the benefits of globalization and attempt to protect what they see as vital or strategic resources. This adds up to a recipe for freezing global economic growth.
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An initial globalization centered around the Industrial Revolution saw the exchange of manufactured goods from a few countries for commodities from many in the rest of the world. The 1970s created globalization through increasingly complex supply chains. The current crises are generating a different sort of globalization, shaped by information flows. There will be marked contrasts in the competence with which societies respond to the new data revolution. Today’s globalization dynamic has the potential to create a revolution of system optimization, making the result of prior technical change cheaper and more accessible. In that sense, it is globalization that constitutes the real Inflation Reduction Act.

So the Fed hiked 25bp today:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated.

Russia’s war against Ukraine is causing tremendous human and economic hardship and is contributing to elevated global uncertainty. The Committee is highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lael Brainard; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Lorie K. Logan; and Christopher J. Waller.

There was some additional information in the press conference:

Powell is giving a clear reason for one reason why the Fed does not plan to stop their campaign, saying that the labor market remains extremely tight. While “the pace of job gains has slowed” the labor market continues to be “out of balance.”
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Powell notes that wage growth is abating, but remains pretty elevated. But he calls job openings — there are 1.9 per every unemployed person — important. And he notes that job creation is strong and quits are high. In short, he still sees a pretty strong job market.
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“There is only one way forward here,” Powell says, when asked about the debt limit: Congress must raise it. Anything else, like planning for what would happen if the debt limit is not raised, would be risky, he says.
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“No one should assume that the Fed can protect the economy” if Congress fails to raise the limit, he adds.
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Investors and policymakers have been in a standoff for a while now, with the Fed indicating it plans to keep rates high and markets expecting the central bank to cut rates later this year as the economy loses momentum. Powell took a shot across investors’ bow just now: “I just don’t see us cutting rates this year,” he said.

PerpetualDiscounts now yield 5.99%, equivalent to 7.79% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.89% on 2023-1-20 and since then the closing price has changed from 15.51 to 15.53, an increase of 13bp in price, with a Duration of 12.36 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies a decline in yield of about 1bp since 1/20 to 4.88%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed to about 290bp from the 295bp reported January 25.

The BoC has announced:

The most recent addition to the Bank of Canada’s set of stakeholder surveys2 is the Market Participants Survey (MPS). The MPS engages a diverse set of participants in financial markets and gathers their views on key macroeconomic and financial variables as well as monetary policy. Bank staff conduct the MPS every quarter to gather timely information in a structured and systematic way and to enhance their monetary policy analysis and advice to Governing Council. MPS results help staff understand how market participants form their expectations and may also, over time, provide useful insights about the effectiveness of the Bank’s communication efforts and its monetary policy.

The pilot phase of the MPS began in 2019. The survey will soon be a permanent part of the Bank’s tool kit. The Bank will publish results regularly, beginning shortly after publication of the January 2023 Monetary Policy Report.

This note describes the MPS’s objectives and main features, its process and design, and how staff use the results.
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Throughout the pilot phase of the MPS, the survey sample was expanded. The current set of 30 participants have been selected based on the following general criteria:

• Relevance of expertise—Participants are senior economists or strategists involved in the areas addressed in the survey. However, survey responses are interpreted as not necessarily representing the view of the respondent’s organization, because not all participating institutions have public or firm-level forecasts. In some cases, people from different areas of an institution have different views (e.g., depending on the institution’s organizational structure, a commercial bank senior economist, an asset-management senior economist and a broker-dealer senior economist—all from the same institution—may have different forecasts and offer different perspectives).
• Representativeness—The sample selection ensures the collection of a diverse set of opinions across institution types (see Chart 1).
• Commitment to participate regularly in the survey—Participants are from institutions that are often involved in market intelligence activities. While participation in the MPS is voluntary, Bank staff work to ensure a high response rate and stability in the sample of respondents over time to maintain the quality of results.

Here’s two of the charts that were used to illustrate the announcement:

Offbeat indices have been used to try and predict inflation. If I remember correctly, Greenspan liked one that had to do with trucks; but there’s another form of transport that has come to the fore:

The Fed was not alone in misreading the implications of the data already available in 2021. The IMF, whose mandate is to take an independent view of developments and policies in member countries, described the inflationary surge in a blog by its (then) chief economist, Gita Gopinath, in the same terms as the Fed, pointing to transitory causes and taking comfort in the anchoring of inflation expectations. Like the Fed, the IMF did not mention in its updates the possibility of economic overheating and inflation persistence.

Fast-forward to spring 2022: the IMF’s World Economic Outlook revealed that the institution’s inflation projections were off by a factor of more than 3 for advanced economies and 2 for all other countries. These facts show that the inflation surprise was global.
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So was there a smoking gun? In a recent study, my coauthors and I focus on a key driver of global inflation that was very evident already in 2021: the rapid increase in global shipping costs. By October 2021, indicators of the cost of shipping containers by maritime freight had increased by over 600 percent from their pre-pandemic levels, while the cost of shipping bulk commodities by sea had more than tripled.

What caused this remarkable increase? As manufacturing activity picked up following extended COVID-19 lockdowns, demand for shipping intermediate inputs (such as energy and raw materials) by sea increased significantly. At the same time, shipping capacity was severely constrained by logistical hurdles and bottlenecks related to pandemic disruptions and shortages of container equipment. Ports around the world lacked workers, who had to self-isolate after testing positive for COVID-19, and public health restrictions prevented truck drivers and ship crews from crossing borders.

Well, here’s a paper that will receive some attention! One of a long series, I’ll bet … The 2021–22 Surge in Inflation by Oleksiy Kryvtsov, Jim MacGee and Luis Uzeda:

The rise in inflation in 2021–22 sparked a growing literature and debate over the causes of the surge as well as the near- and medium-term path for inflation. This review offers three key messages. First, the exceptional nature of shocks resulting from the COVID-19 pandemic and geopolitical events drove the surge in inflation and the initial underestimation by many central banks of the extent of inflationary pressures. Second, the pandemic may have
accelerated structural changes in goods and labour markets, which are likely to put pressure on goods prices and wages in the medium and long term. Third, the resulting shifts in relative prices for goods, services and labour are unlikely to be large enough to threaten a return of inflation to target but may require somewhat higher interest rates than those in the decade before the pandemic.

My favourite chart is:

TXPR closed at 576.60, down 0.65% on the day. Volume today was 1.21-million, near the median of the past 21 trading days.

CPD closed at 11.47, down 0.78% on the day. Volume was 93,580, slightly below the median of the past 21 trading days.

ZPR closed at 9.525, down 0.16% on the day. Volume was 171,820, well below the median of the past 21 trading days.

Five-year Canada yields were were down to 2.90% today.

The preferred market was weak all day, but it was a late day collapse that did the damage in our sector. More generally, pundits blamed earnings:

The S&P 500 ended nominally lower on Wednesday as a string of corporate earnings ran the gamut from downbeat to dismal, reviving worries over the economic impact of the U.S. Federal Reserve’s restrictive policy. The TSX also closed with a modest loss, as market players took in what could be the final Bank of Canada rate hike for this monetary tightening cycle and began aggressively pricing in the possibility of interest rate cuts before year end.

The S&P/TSX Composite index and all three major U.S. stock indexes pared their losses throughout the afternoon to close well off session lows, with the blue-chip Dow eking out a small gain in the final minutes.

The tech-laden Nasdaq was weighed down after Microsoft Corp, the first major technology firm to post quarterly results, offered dour guidance and raised red flags with respect to its megacap peers which have yet to report.
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Interest rate probabilities show about 89% odds of the bank making no change to its overnight rate at its next announcement on March 8, according to Refinitiv Eikon data.

But following the bank’s 10 am announcement and Monetary Policy Report, credit markets started making their most aggressive bets yet that the central bank’s key lending rate will start coming down later this year as the bank shifts from inflation fighting to providing support to a slowing economy. They are now fully pricing in a 25 basis point cut by the Oct. 25 Bank of Canada meeting. And they are positioned for an overnight rate of 4.07% by the Dec. 6 meeting. That implies money markets are getting close to pricing in a 50 basis point cut in the overnight rate by the end of this year.

PerpetualDiscounts now yield 5.99%, equivalent to 7.79% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.89% on 2023-1-20 and since then the closing price has changed from 15.51 to 15.59, an increase of 52bp in price, with a Duration of 12.36 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies a decline in yield of about 4bp since 1/20 to 4.85%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed to about 295bp from the 305bp reported January 18.