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Chief Economist Eugenio J. Alemán discusses current economic conditions.

We have read this, or a version of this question, in many reports lately. It seems as if there is a race to the finish line for being the first to introduce a new trendy concept/issue. There may be a prize at the finish line, who knows!

We have read that this is World War III, or that the conditions that allowed for low inflation before the pandemic are no longer there; that ‘deglobalization’—didn’t we use to call this ‘reshoring’ and it was trendy several years ago? Anyway, the last time I checked, American firms were still producing lots of goods in China and/or importing lots of goods.

Some argue that there are structural changes, rather than cyclical issues, that are changing the way inflation needs to be tackled by the Federal Reserve (Fed), etc.

We will delve into some of these issues in the future. However, for now, markets must be clear that if there is anything the Fed knows, it is how to fight inflation. Yes, it could become very costly, especially in terms of employment and output lost, but markets should not second guess the Fed’s institutional memory regarding how to fight inflation, even if the institution missed an opportunity to get ahead of the curve early in the process, because markets will not like what the Fed has in store for them!

To all those who are saying that high inflation is here to stay I would remind them of Milton Friedman’s famous phrase that “inflation is always and everywhere a monetary phenomenon.” For laymen and laywomen, this may translate into something like this: fish cannot live in rivers that carry no water. If rivers dry out, the fish living in those rivers die, period!

The same thing happens to inflation, in the long term, if you cut the spigot of money supply then inflation ends. How does the Fed reduce the money supply, you may ask? By increasing interest rates—the process is a bit more complicated than just increasing interest rates, but it is enough to make the point—which is what the Fed has been doing for seven months. It doesn’t matter whether this latest increase in inflation was caused by the business cycle, by structural factors, by the recovery from the pandemic, by supply chain issues, or by an overly extended fiscal sector that kept incomes above what they otherwise would have been.

Thus, an independent central bank like the Federal Reserve, will have no issue continuing to increase interest rates to kill inflation, i.e., dry the river, and this is important for markets to internalize, no matter if the reason for why inflation is higher today is one of the ones mentioned above or if it was because Martians came down to earth and pushed prices higher.

Immigration Reform Could Help In the Effort

We know that the issue of immigration is, sometimes, politically charged. But we are not going to use political arguments for the need for immigration reform. That is, the Fed will probably be very happy if the political system finally decides to take immigration reform head on, as this will help them in bringing inflation down without having to take the US economy into a steep recession.

In our Weekly Economics of August 18, 2022, we argued that the US unemployment rate in July 2022 was at 3.5%, the lowest rate of unemployment in almost 50 years. However, we also said that this low unemployment rate was achieved with more than 500,000 less workers that when the US economy hit that rate of unemployment just before the COVID-19 pandemic in February of 2020. One of the reasons for this difference is that there are many more Americans who have decided to retire (some have called this period the ‘Great Resignation’), while others have no incentive to get back into the labor force at current wages. And we also showed that real wages and salaries in both the goods producing sector as well as in the services providing sector have declined considerably since the start of the COVID-19 recession because inflation has been higher than what these workers are getting from increases in nominal wages and salaries.

However, for some workers in the service providing sector, real salaries are still higher today in real terms. This is the case for workers in the leisure and hospitality sector, who have gotten increases in wages and salaries that are higher than the rate of inflation to compete with other sectors in attracting workers. One of the reasons may be related to the increase in the opportunity cost for these types of workers, who must deal face to face with customers and are at a greater risk for contracting COVID-19. Thus, a well thought out bipartisan immigration reform will help the Fed bring down the rate of inflation so it does not have to increase interest rates so much that it takes the US economy into a severe recession that lasts for longer.

Student Loan Forgiveness

The Biden Administration announced that it will cancel up to $10,000 of debt for federal student loan holders, and up to $20,000 for those who have received Pell Grants, which are given to low-income students. Since the decision is not going to go through Congress, it could be challenged in court so there is a chance that the measure is not implemented. However, if the plan moves forward, the measure will reduce the amount owed by borrowers, but especially from low-income students.

According to our Washington Policy Analyst, Ed Mills, ~43 million borrowers will be impacted by this action, with ~20 million borrowers having the entirety of their student loan debt canceled. These savings are likely to be spent elsewhere, pushing consumer demand slightly higher but probably not enough to add upward pressures on inflation.

The plan also extends the moratorium on student loan payments until December 31, 2022, at which time it will probably put some further strain on some of these individuals’ incomes. However, perhaps the most important effect will be for those that have paid their loans for several years and are close to full repayment, as they will probably be close to having their student debt completely paid, i.e., those students that only owe approximately $10,000 or less.

There is always the possibility that this measure could create issues in the future as individuals borrow more because there is the possibility of being saved by the government. However, this is probably not very different than an individual or a company using the bankruptcy court to wipe out their debts if their borrowing decisions went awry. It is true that if this happened, these individuals and firms would be ‘punished’ with several years of bad credit, which is why some influential Democrats were calling for the Biden administration to allow student loan debts, which cannot be discharged in bankruptcy court, to be included in the bankruptcy process.

Jackson Hole

With today’s more hawkish speech by Federal Reserve Chairman Jerome Powell at Jackson Hole we have made a change to our federal funds rate forecast for next year. We are now expecting the federal funds rate will remain at 3.25 to 3.50 for the rest of 2023.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

Industrial production: Industrial and production engineering is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

FHFA house price index is a quarterly index that measures average changes in housing prices based on sales or refinancing’s of single-family homes whose mortgages have been purchased or securitized by Fannie Mae or Freddie Mac.

Consumer confidence index is an economic indicator published by various organizations in several countries. In simple terms, increased consumer confidence indicates economic growth in which consumers are spending money, indicating higher consumption.

ISM Manufacturing indexes are economic indicators derived from monthly surveys of private sector companies.

ISM Services Index is an economic index based on surveys of more than 400 non-manufacturing (or services) firms’ purchasing and supply executives.

Non-Manufacturing Business Activity Index is a seasonally adjusted index released by the Institute for Supply Management measuring business activity and conditions in the United States service economy as part of the Non-Manufacturing ISM Report on Business.

New orders index measures the value of the orders received in the course of the month by French companies with over 20 employees in the manufacturing industries working on orders.

Source: FactSet, data as of 6/3/2022