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The uphill task of a data-dependent Federal Reserve

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The market has been on a roll of bulls with occasional pullbacks. Buying the dip works again, a familiar occurrence in 2023 where any retracement saw funds flowing in to support the equity market. 

Year to date, the S&P 500 has climbed by almost 10%, a remarkable feat that was virtually unimaginable after a meteoric rise in 2023. Federal Reserve officials are fine-tuning monetary policy to achieve a soft landing. The constant questions lie in the probability of a recession occurring and the state of the economy. 

Unveiling the economy’s health has proven to be an art rather than a science. Recent data has shown mixed signals on the economy’s strength and resilience, which has complicated the Federal Reserve’s task of returning inflation to its 2% target and how it conducts its monetary policy. After all, they are concerned about the premature loosening of interest rates that could result in warming inflation. 

A look at the payrolls and GDP data points has investors cheering on the robust economy. Inflation continued to cool on a macro level despite recent data suggesting the likelihood of re-acceleration in the economy’s general price level. 

A dive into data from The Bureau of Labor Statistics (BLS)

The BLS monthly data points are crucial in helping us understand the labour market. This data is divided into two components: the household and payroll surveys. In recent months, we have seen conflicting signals about the labour market from the BLS survey. 

The household survey data showed a drop of 184,000 jobs for February, the third consecutive fall in jobs. On the contrary, the payroll survey depicted a firmer figure, showing more than 200,000 jobs created monthly for the past six months. 

Given the BLS report’s smaller sample size, it should not be seen as a better measurement than the nonfarm payroll report. However, economists view the BLS report as a critical pivotal labour market assessment. 

What is the nature of most job gains?

A look at key labour market trends also reviewed some unsettling trends. Based on the household survey, many of the new jobs for the past 12 months appeared to be part-time. 

One can also observe a slight contraction of full-time jobs. As such, despite a somewhat overwhelming strong labour figure seen recently, the economy might not be as resilient as one might have expected. Should the economy tilt towards a lower growth engine due to the persistently high real interest rate, this part-time job growth may start to dwindle and further escalate to a softening labour market rapidly. This will dilute the odds of a soft landing.

Where does the inflation narrative stand? 

Policymakers’ uphill task in deciding the right tools to diagnose and keep the economic engine going is confounded by the degree to which inflation remains sticky. While both the Consumer Price Index (CPI) and the Fed’s favourite inflation indicator, the Personal-Consumption Expenditures (PCE) Price Index, have shown leaps and bounds of improvement in cooling inflation, there is a stark contrast in how far it has reached the Fed’s target of 2%. 

The headline CPI in January was 3.1% annually, while the PCE index was 2.4%. The data show a substantial divergence when we exclude the more volatile components, such as food and energy prices. 

As Federal Reserve chairman, Powell likes to compare inflation in the goods and service sectors; the progress in these components is also on a diverse path. After a persistent fall in goods prices, we now see some strength in prices for goods. After the release of Tuesday’s CPI, we see that supercore services inflation, excluding housing, rose 4.4% in February annually. And the degree of inflation within these categories put many Federal Reserve officials on the fence. When one is uncertain, stay very still- that’s the recipe many central bankers subscribe to and are thus reluctant to reduce interest rates. 

Hence, even as Jerome Powell likes the Fed to maintain its data-dependent stance, the interpretation, signal, and predictive nature of the economic data might prove to be an art rather than a science, perhaps more subjective in judgement than an objective-orientated approach towards an economic-based model in modern monetary policy. 

For now, the economic news is still music to investors’ ears until the tide reverses—God knows when. 

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