Powell’s Peril Lies in Lanquishing Labor Market
Fed Chair Jerome Powell did the best he could with the limited options the Fed has created for itself, and he said nothing unexpected. The Fed will continue its course at a slower rate of interest rate increases but raise interest to a higher level than it has thought it would have to all year and higher than the stock market has believed.
All totally as expected here, but causing the market to lose all of what little lift it got the day before from the improving inflation rate because it didn’t expect enough.
So, the S&P and Nasdaq remain bound within the bear-market trading range they have been in all year, and the Dow, which broke out of that range, looks to be headed back down into it.
While there were no surprises, one of the dominant themes was the blind spot I pointed out a few months ago that I said the Fed would get hung up on, causing it to over-tighten as it moves forward. Powell took any doubt off of that by saying multiple times during his prepared speech and his Q&A time afterward that the one signal the Fed will be watching more than any to figure out when to stop raising interest rates is a meaningful move up in unemployment.
The misunderstanding of languishing labor
While Powell continues to say the labor market is strong, he confirmed that that labor force (the number of people ages 16 and older who are employed or actively seeking employment) is badly broken and won’t likely recover for some time. He stated the same numbers I gave months ago, which is that size of the overall labor force is about 4,000,000 workers lower than where it would be if the longstanding and consistent trend for growth in the participating labor force had not been broken by the Covidcrash. For the second time that I’ve heard (his Brookings talk being the first), Powell is now recognizing the contributing cause I pointed out back in September, which is the number of Covid-related deaths and illnesses.
So, Powell is coming along in recognizing the labor market is broken and why; yet, he keeps saying it is strong because there are far more jobs open than there are laborers. I keep hearing that serious misconception all over the place:
AP repeated the error even when it wrote at the start of this week about the serious ramifications of the wounded labor force:
So, the leading-edge news I gave months ago about the true situation in the labor market is finally filtering through the mainstream press: part of the cause of the labor shortage is Covid-related deaths and illnesses (without stating that some of what is called “long Covid” could be vaccine injuries). They state that this shortfall in workers is going to continue to fuel wage inflation, which will fuel general inflation well into 2023.
Powell reiterated today the following points, which AP noted he made in recent speeches before this week’s FOMC meeting:
Powell is assuming 2-million of these lost laborers are due to “excess retirements,” but the Brookings Institute says, at least 2-million and likely 4-million are due to “long Covid.” Powell is moving into the Covid camp, but not all the way there yet. The importance of this realization is that dead workers clearly will never come back and those with longterm illnesses, regardless of how they got them, may not ever be able to come back either.
So, Powell admitted this shortfall is going to endure, and he also said the numbers may actually be much higher than the 3.5-4-million, which he acknowledged today is the conservative number for the shortfall. He also said there are many other paths by which you can reasonably argue for a much higher shortfall in the participating labor pool.
The impact of this labor crisis on GDP is significant. You may have already seen the reality of what AP reports in your own life, and I know I have seen it at many establishments in my own small farm-town community:
I’ve gone into a number of local restaurants where I have been told or read over the past year that the menu was cut back due to labor shortages and/or that open hours or days were cut back in order to do what they could with the labor pool available to them. Thus, AP here confirms what I’ve been saying about how you cannot have a serious reduction in the labor force and not have a reduction in production, whether of services or goods. AP notes that improved efficiency could make up the difference, but states that it is not making up the difference and that, in fact, efficiency, such as through automation, has gone down.
Of course a reduction in production (GDP) IS a recession by definition. Typically, the only argument is over how long GDP has to be in decline before we call it a “recession.” Well, that was until the argument recently shifted to say declining GDP simply has to be wrong because“the labor market is strong.”
The irrationality of this argument is that the shortage of labor that is causing production to drop proves we cannot be experiencing a recession (a drop in production). That is, on the face of it, completely irrational, but it comes from entrenched thinking that believes the only cause of a shortfall in labor is an economy that is booming along so strongly that demand for labor is exceeding labor supply due to economic growth running ahead of labor growth.
This misconception is everywhere because we’ve never seen a massive drop-off like this in labor supply, so those writing about it don’t know how to get their heads around it. They interpret it only from the framework they have known all their lives. Thus we see AP, even in this article, which lays out the reasons for the labor shortfall, repeat the exact same mistake:
It is mind-boggling to me that they cannot see that labor is languishing even as they describe the internal of causes of labor shortages. How is a labor market that is short, at least, 4,000,000 workers — many of whom died and many of whom now have longterm illnesses — “robust?” Is death robust? Is illness robust? Is a SHORTFALL of 4-million workers “robust?”
They cannot wrap their head around the fact that this is a sick, even dying, labor market that Powell now wants to hit on the head to knock it down further Thus, Powell repeatedly stated today the same point that AP made ahead of today’s meeting:
Think all of that through, and you’ll realize the incredible peril involved in thinking the reason we cannot be in a recession after two quarters of receding GDP is that “the labor market is strong.” Powell drove this point home by making it clear the Fed had to see unemployment rise before it will stop increasing interest rates and simply leave them high for longer.
Here is how you think it through:
THAT is the great peril here. The Fed could make shortages so much worse at a time when we already have too few workers to produce the goods and services we want or need that we could hit Great Depression levels, especially given the long lag effect between Fed policy and then between job losses and inventory draw downs as shortages in inventory in some businesses result in shortages in inventory in other businesses that cannot get ingredients or parts. Reduced production, worsening shortages, could likely cause a resurgence in inflation before the Fed is even finished battling it. (And will the Fed even understand the resurgence when it hits, or will it continue to think that means it needs to tighten down on employment even harder?)
Misunderstanding the present labor market by thinking it is strong is likely to prove to be the worst mistake the Fed has ever made. And THAT is the scenario I’m predicting for 2023. 2022 was all about shortages leading to inflation leading to Fed tightening, leading to stock and bond market crashes, all of which we saw. 2023 becomes all about the dire failure of the inflation recovery plan, resulting in worse shortages and possibly a resurgent inflation problem that is more deeply entrenched, and an amplified recession because the Fed doesn’t believe in the present recession solely due to its false belief in a robust labor market, rather than a sick and languishing labor market.
They did. Powell said the new normal unemployment rate, given the labor shortage, might be 4.5%, and that it might take a higher rate than that to get inflation down. Don’t ask me why that makes sense because it doesn’t in a time where too few jobs are producing anything. (Remember, an unfilled job produces nothing.)
Terminal interest may be terminal indeed
More important than the employment rate Powell is looking for to drive wage-based inflation down is the terminal interest rate he sees as necessary to get there because that will upset every market.
In his speech today, Powell showed graphs of the Fed’s dot plots and stated repeatedly — just as AP reported the Fed has said in the recent past — that the Fed will not lower interest rates at all in 2023. No pivot! While the Fed will make its interest-rate decisions based on the data available to it at each meeting, Powell spelled out that he did not see any chance the Fed would lower interest rates in 2023, nor did any other Fed FOMC member.
Here is how Fed members revised their collective dot-plot projections for interest rate changes higher up and extending further out at today’s meeting from where they were at the last meeting: (Each blue dot is one Fed member’s projection at the present meeting of where the Fed’s highest base rate will be in each year ahead, while the red line tracks the median level in each column. The gray line and gray dots show what Fed members had projected at their September meeting.)
Powell admitted that ALL of of the Fed’s dot plots for terminal interest rates had been too low all year long so they were revised upward at each subsequent meeting. Then he admitted the Fed had to revise them upward again at this meeting to a projected terminal rate around 5.25%. Moreover, he said he could not say with any confidence the Fed was not underestimating this time by just as much as all the previous times.
In fact, it’s been longer than all year long that Fed members have had to revise their projections upward. Here is where the Fed set its overnight-interest-rate projections for the year 2023 at each Fed meeting (blue dots) in past months. You can see how, at each meeting since March, 2021, the Fed has had to raise its projections (thin red line) higher for the highest interest level it believes the Fed Funds Rate will need to reach in 2023: (Each column of dot clusters are the member’s projections for that month as to where interest would peak in 2023.)
That is a lot of serious underestimation for 2023’s terminal interest rate at each meeting along the way, and Powell looked a little embarrassed in saying today they all had to revise upward again at this meeting, and that he couldn’t promise they wouldn’t have to do so again at the next meeting.
Stocks still have it wrong, but they will get it right if it kills them … and it will!
Blackrock, the Fed’s agent for everything these days, warned the stock market yesterday,
“Never going to happen,” said I. “No pivot!”
Powell pounded that point in the Q&A today since the idiot market refuses to accept it, saying he saw no situation in which that would possibly happen or even be considered.
“Not going to happen,” said Powell … and Blackrock … and they both ought to know as they work hand-in-hand right at the core of all of this. Not going to happen.
One other thing that I said was likely to weigh on stocks in the final quarter of 2022 was contrary to what Zero Hedge was saying. They said buybacks would start back up and carry the market higher, but I said buybacks were going to diminish because corporate leaders do not like to buy back their stocks in a recession. And, today that was confirmed by Bloomberg:
Bloomberg presented the following graph of their data:
I’m sure you’ll see those stair steps go down another notch in Q4 now that Powell stated today the Fed has finally gotten into “restrictive territory,” which is why it is slowing the rate at which it raises interest in order to ease deeper into that restrictive territory with a little more caution.
And, of course, “restrictive territory” is where you see the breakdowns start to occur as emerged first in crypto markets recently, but the Fed is taking us deeper into a recession Blackrock now says is a “foretold” conclusion and one that might easily become “severe” because there will be no Fed support possible when the deeper crash hits due to inflation.
“Foretold,” indeed. This is right where I said many months ago all of this would end up this year. In fact, every step of the way, was foretold here; and I’m going to lay that all out tomorrow as a path of stepping stones the Fed apparently could not resist and neither could the stock market. Every step of the way.
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