Light In The Tunnel

Insights | Light In The Tunnel
Fed Hour glass

Author: David I. Templeton, CFA, Principal and Portfolio Manager

A critical factor contributing to the market's downward trajectory this year is the high level of inflation permeating through the economy and the Federal Reserve's response in addressing this issue, i.e., higher interest rates. The Fed has increased the Fed Fund's target interest rate by .75% in each of the last three rate announcements and a total of three percentage points this year. The magnitude of the increase is the largest year over year change since any other Fed hiking cycle as seen in the below chart. This tighter monetary policy is an effort on the Fed's part to reduce economic activity that leads to lower demand that leads to lower inflation.

Fed Funds year over year rate of change

I have noted a number of times in earlier blog posts the pandemic and the related shutdowns create a unique environment making it difficult to interpret some of the recent economic data and its future impacts. It seems the pace of the Fed's tightening cycle, especially increasing rates from near zero percent, is not being given enough time to see the impact to economic activity and inflation. There are recent signs the higher rates are beginning to slow activity and importantly reduce inflation. Earlier this week the ISM Manufacturing Prices Paid Index showed a further decline to 51.7. As the below chart shows, the Prices Paid data tends to lead inflation by approximately three months.

ISM Prices Paid Index along with CPA (inflation), September 2022.

Other data points are surfacing that might suggest a peaking of inflation as well. The tight labor market has the attention of the Fed as well since higher wage levels tend to lead to higher inflation. The Job Openings and Labor Turnover Survey this week showed a continued decline in job openings. The openings level of 10 million jobs is high; however, it is down from nearly 12 million openings in March of this year. Also noted on the below chart is an uptick in the number of individuals unemployed at 6 million in August, up from 5.6 million in July.

Job Openings and Labor Turnover Survey August 2022

Inflation may yet be a significant issue the Fed needs to address; however, it seems reasonable to take an interim step of seeing whether or not the current tightening is having success in reining in inflation. The next FOMC meeting is November 1-2 and more economic data will be reported between now and then to provide more clarity on the magnitude of the Fed's next interest rate decision. Just maybe there is some light at the end of the tunnel and the inflation Jeannie is being squeezed back into the bottle.

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