It’s the ace up the Fed’s sleeve

After five days of selling, the major market averages finally ended in positive territory yesterday, as they continue to consolidate November’s gains, while remaining above their respective 50-day moving averages. The recent setback has been welcome, but it It will be the upcoming Producer and Consumer Price reports that will dictate whether this is a pause for refreshment or the start of a deeper decline. Both of these reports are expected to weigh heavily on the Fed’s updated policy outlook at next week’s meeting, which is the last major event of 2022.

With a high degree of certainty, the Fed will raise its benchmark rate from a range of 3.75-4% to 4.25-4.5%, but it is the “dot-plot” that shows where each member sees the short-term rate in 2023 and beyond, this will likely dictate market performance for the rest of this year. Rate increases to date, combined with free market forces, have put the peak rate of inflation behind us and are clearly leading to a price deceleration that should widen and accelerate next year. Wholesale used car prices fell to their lowest level in a year last month, according to the Manheim Used Vehicle Index, as interest rates rise and availability improves .

After more than doubling mortgage rates, home prices are falling for the first time in 10 years, which is also weighing on new rental rates across the country. Yet this is an orderly decline that does not seem to have the same repercussions as those seen when the housing bubble burst in 2008. Banks are much better capitalized and have less leverage, while that the quality of mortgage credit has improved significantly.

More importantly for the Fed, we see wage growth beginning to slow as the Indeed jobs platform forecasts a return to pre-pandemic levels in its index, which is based on job posting wages. on his site. Wage growth of 6.5% in November is down from 9% in March this year, and is expected to fall to 3%-4% next year, based on its current trajectory.

The Fed has been most effective yet in stemming price increases in financial markets, as the speculative fervor that reigned in markets in 2021 has been shattered. We don’t hear about meme stocks or SPACS anymore, and what was a $3 trillion cryptocurrency industry has lost two-thirds of its value. The wealth effect is no more, but this collapse in speculation and the bear market in stocks and bonds has not upset the expansion for one very important reason, which is the ace in the sleeve of the Fed in terms of sailing a soft landing for the economy next year.

The biggest uncertainty now, as inflation apprehensions shift to growth, is how far and for how long the Fed can raise interest rates to keep inflation under control without ending to expansion. Most consider the mountain of excess savings that has accumulated through pandemic relief programs over the past two years to be part of the inflationary problem, but I think it is now the greatest asset of the Fed. In effect, it serves as a buffer for the tightening of monetary policy by the Fed. It may have been inflationary in 2021 as consumers shifted their spending from goods to services, but now it’s just helping to offset the drop in real wages resulting from the spike in inflation. That’s why we haven’t seen a decline in real consumer spending. The good news for the Fed is that this is a temporary buffer. As the rate of inflation decreases, the savings surplus should also decrease, eliminating it as a future inflationary threat.

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