Inflation Prints Put Short-Term Pressure On Fed, Atlanta Fed Study Suggests 25% of Labor Decline From Substance Abuse

There were more hot inflation numbers this week. CPI came in at 8.5% which was the highest pace in over four decades. PPI was even higher at 11.2%. This was the seventh consecutive increase in inflation. The news of course was more complex than just the headline number. White-hot numbers were expected but core CPI increased at a less frequent clip than economists expected. In fact, core CPI only rose 0.3% in March compared to an expected pace of 0.5% that was seen in February.

The contribution of gas, shelter, and food contributed more to headline inflation than previous readings which may suggest inflationary pressure is making its way to crucial parts of the consumer wallet. Interestingly, despite the hot CPI and PPI data, the Fed Funds futures came down from an expectation of 9 hikes to 8 hikes. Our Head of Research, Tom Lee, believes this reflects that the bond market is comfortable with the Fed’s current approach.

Still, some economists expressed optimism that the softening of the core index is foretelling a more general slowdown on the horizon. Of course, for a Fed taking a more hawkish bent, this data seems to give the hawks more ammunition. Federal Reserve Board member Christopher Waller appeared to give some credence to this notion. He went on the CNBC’s Closing Bell for an interview. He said some hawkish things, but also postulated that inflation was near a peak. He reiterated that he preferred a “front-leading approach” to rates. Indeed, this may be partially what is persuading the doves to a more temporarily hawkish position. He said he thought the economy had the strength to handle higher rates.

One thing that was encouraging about Waller’s comments was that he specifically said that trying to shock markets would not be productive. He made a purposeful distinction between the situation we now face, and the situation faced by Chairman Volcker during the Great Inflation. He noted that Volcker was fighting persistently high inflationary pressure that had been building for years. Furthermore, he noted that the Fed cannot produce

Everyone can agree that the Fed was wrong on their projections for inflation and if we get to “neutral” more quickly, which Fed economists estimate in the ballpark of 250 bps, then they may be able to better acclimate themselves. Some doves like Lael Brainerd and Charles Evans have said they would like to get to neutral and reassess. But the key here is that we’re a long way from neutral still and both the doves and hawks agree we want to get there. The hawks would like to go above neutral, but this may be the next big debate between the cadres if not curveballs come between now and then. Of course, with a ground war raging in Europe that could be a big ask.  Bullard, for his part, said it was a “fantasy” that inflation will abate without going above neutral. He prefers getting to 3.5% by year-end.

Black Rock Strategists came out with a different take. The BlackRock Investment Institute estimates that if the Fed were to bring inflation down to its desired target of 2% that the collateral damage to the economy would result in an unemployment rate in the neighborhood of 10%. This high level hasn’t been seen since the aftermath of the Global Financial Crisis. Obviously, this is not a desirable outcome and it would have great political ramifications as well. They base this estimate on the historical relationship between inflation and employment. Researchers from the Atlanta Fed published an interesting study that may have identified a major contributor to labor force tightness. One idiosyncratic factor associated with the pandemic was that many folks exited the labor force to take care of loved ones or because they feared professions that put them at health risk. The paper these researchers published did some compelling research that suggested increasing rates of substance abuse, both alcohol and drugs, could be responsible for 9% to 26% of the decline in the prime-age labor force. The period they analyzed was from February 2020 to June 2021. This doesn’t include the high death rates from drug overdoses. Details will be provided on Quantitative Tightening at the May meeting. The benchmark yield on the 10-Year Yield was 283 bps.

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