Ingrams June 2023

IN A NUTSHELL

by Ken Herman

Sideline Money Fueling the Market

Even if the Fed waits on higher rates in June, look for them in July. In the meantime, be on watch for a rally-triggering spark. A tremendous amount of cash is sitting on the investment world sidelines, which could pour into the stock market and spark a major market rally at any unknown day or hour as soon as there is a significant “spark.” That spark could have been the first unemployment report of June, which to many, was hard to interpret and hard to understand. It is difficult to say which was the bigger surprise: The huge, unexpected rise in payrolls or the equally huge, unexpected rise in the unemployment rate. From the Fed’s perspective, the rise in unemployment—coupled with the drop in average hourly earnings—should outweigh the shock of another huge job gain. Maybe the weaker numbers stand in support of a pause they were leaning toward, anyway. That said, bear in mind the rate of improvement in year-over-year average hourly earnings is slowing. And the Why does that matter? Because wage inflation boosts overall inflation for two reasons: First, because costs rise; second, because income growth allows producers to pass costs on. Wage costs are rising fast, even in low-paying industries, which is one reason restaurant prices are still rapidly rising. And total income growth is strong. More people working, even in lower-paying jobs, generate more income. In other words, if the Fed were really worried about the inflationary implications of this report, it would raise rates. But because it’s also worried about tightening credit conditions, it’s inclined to pause. Because there is not much to lose by waiting to hike rates again in July, the Fed is more likely to emphasize the rise in unemployment and drop in average hourly earnings growth. There has been progress in the inflation fight, but perhaps not enough. In a recent Fed news conference, chairman Jay Powell explained the Fed was seriously considering pausing rate hikes at the June meeting. He teed up the decision as a choice between raising rates because inflation is not falling fast enough or pausing drop, not just this month but in the past year, reflects the shifting composition of labor because the most rapid job gains are in the lowest-paying categories. The Inflation Factor

to give the Federal Open Markets Committee time to process the deg ree of bank credit tightening. At that time, the committee was leaning toward pausing, mostly out of concern for tightening bank credit conditions. Powell also emphasized that inflation was slowing without dwelling on the details. Most other FOMC participants, at least most of those who have weighed in since then, have not been as sanguine. The big picture looks good, but there are still real problems in the details, even beyond the slow pace of core CPI improvement. Wall Street, however, does not think inflation is falling fast enough to convince a majority of the Fed

members that cuts are justified, and in fact, believes the Fed is not even really pausing if rates do not rise. Rather, maybe they are slowing their tightening pace from a quarter point at every me eting to a quarter point at every other meeting. If the Fed opts

In the continuing battle against inflation, the big picture looks good. But problems remain in the details of how the Fed will act in the coming months.

to leave rates unchanged in June, it will very likely hike them in July. When the Fed raised rates over a short stretch from 2017 to 2019, members did so at every other meeting because they were not sure how far rates should rise, and they wanted more time to see the result of rate hikes. This could be the same approach. The distinction between pausing and skipping is not just semantic hair-splitting. It is a meaningful distinction bearing on how policy will be conducted after the June decision.

Ken Herman served as the Managing Director of Bank of America Global Capital Markets and was the Mayor of and served on the City Council in

Glendora, Calif. E | Editorial@

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June 2023

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