Fed Finds Itself Between a Rock and a Hard Place
Investors should not be cheering for stagflation.
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The BLS Jobs report that hit before the bell on Friday showed that 175,000 positions were created in April. This was far below the 243,000 consensus. The miss pushed the yield on the 10-Year Treasury down to just over 4.5% on hopes that the waning strength in the jobs market might hasten a cut to the Fed Funds rate by summer.
This is turn ignited a big rally in equities with the Nasdaq gaining 2% while the Dow and S&P 500 roughly rose one and a quarter percent apiece. Oil fell to just below $78 a barrel on the WTI.
Before the jobs report hit Friday morning, BofA’s chief strategist said that a weaker than expected BLS jobs number could set up a sell-off in the market as it would increase fears of stagflation. Obviously, that did not happen, at least not on Friday. That said, the observation bears consideration as the Federal Reserve finds itself increasingly between a rock and a hard place.
On one hand, economic growth is clearly slowing. After a print of 4.9% in the third quarter, GDP growth fell to 3.4% in fourth quarter and a preliminary reading of just 1.6% in the first quarter of this job. The jobs markets also seem to be losing attitude. Friday’s BLS report was weak and March JOLTs report showed the fewest job openings in three years. I am sure in a different economic environment that the Fed would already be cutting rates.
Unfortunately, inflation has become quite ‘sticky’ in the last few months. The central bank has had a dual mandate since 1977 of both ensuring sound money and maintaining full employment. This mandate was one of many poorly thought-out and reactionary policies that happened in the 70s in the time of bell bottom jeans and 8-track tapes.
Government institutions have a poor historical record of being able to deliver against their primary directive, giving them an additional key mission is just asking for trouble. Along with abandoning the last vestiges of a gold-based currency system in 1971, these two policies have been significant contributors to the dollar losing more than 98% of its buying power over the past half century.
The dilemma for the central bank is if it starts to cut rates, it could easily put additional upward pressure on inflation levels. If it doesn’t, the economy could stall further. Many investors are going to be laser like focused on this dynamic in the months ahead and financial pundits will engage in many ‘will they or won’t they’ discussions. Then there will be the additional political pressure put upon the ‘independent’ Fed as this is an election year to boot.
It may come to a point where Chairman Powell feels he has little choice but to reduce rates even before he is fully confident that the inflation genie has been put back in the bottle. However, that action would increase the chances of a stagflationary environment settling in across the economy. And that is not something investors should be cheering.
At the time of publication, Bret Jensen had no position in the securities mentioned.
