The S&P 500 closed 1.6% lower on Tuesday, the Nasdaq lost 2%, and the Dow Jones tumbled 570 points as investors assessed economic data indicating rising labor costs and declining consumer confidence ahead of Federal Reserve decision.
Labor costs in the US rose more than expected last quarter, up by 1.2%, indicating a rise in wage pressures and consumer confidence dropped to its lowest level in over 1-1/2 years.
Also, GE Healthcare sank 14.3% following a Q1 revenue shortfall.
Coca-Cola lost 0.4% despite exceeding estimates and improving its outlook.
Conversely, 3M jumped 4.9% on upbeat results and Eli Lilly surged 6% after the EPS beat forecasts on higher sales of weight loss drugs.
There was broad-based selling across markets: Stocks, bonds, commodities, everything.
It started with hotter than expected wage data (Q1 employment cost index). With the Fed decision today, on the back of hotter than expected inflation data in recent months, the influence of rising wages on the inflation picture spooked markets.
But it's an overreaction. Why? Remember, we're in a productivity boom!
We averaged just 1% productivity growth for the decade prior to the pandemic, and negative 0.7% from the fourth quarter of 2020 through early last year. Since then, productivity growth has averaged 3.7%.
And as Jerome Powell has said in the past, wage gains should equal productivity gains plus inflation (a formula of non-inflationary wage growth).
The latest inflation of 2.7% plus 3.7% productivity, gives us year-over-year wage gains of 6.4%. The wage number yesterday morning was 4.2% (year-over-year rise). That means wages should be rising faster.
With the above said, among the important events of the week (Fed, earnings, Friday's job report), the Q1 productivity report on Thursday is a big one. Let's take a look at a couple of charts as we head into the Fed decision …
Relating to the above chart, it's important to remember that the Fed made an official policy change in the way they evaluate their 2% inflation target back in September of 2020.
Inflation had been too low, for too long.
For the better part of the prior decade, inflation ran well below their two percent target. So, Jay and company told us explicitly that they would let inflation run hot, to bring inflation back to 2% on average, over time.
They've done just that. The above is the chart of the Fed's stated inflation target, "annual change in the price index for personal consumption expenditures (PCE)." They countered thirteen years of weak inflation, with two years of hot inflation, for an average of 2%.
Let's see how the path of inflation looks if we extrapolate out a 2% annualised rate of growth in the PCE index, from the pre-Lehman peak of 2008.
This chart shows us what the actual path (the blue line) PCE looks like compared to its desired 2% annualised inflation path (the orange line). Remember, the Fed told us throughout the extended period of weaker than trend inflation, that they would let inflation run hot, to bring inflation back to 2% on average, over time.
This chart would argue that the Fed should be less concerned about splitting hairs over tenths of a tick on inflation readings (especially as it resides comfortably under 3%), and it should be more concerned with its overly-tight policy stance impeding an economic boom, which could recover the underperformance of the prior decade (the decade that also delivered below target inflation).
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