Every economic age has its dominant phrase. Think of the ‘irrational exuberance’ which then-Federal Reserve Chair Alan Greenspan fretted about during the 1990’s dot-com bubble. If that’s too far back for you, what about European Central Bank chief Mario Draghi in 2012 promising skeptical markets that he’d do ‘whatever it takes’ to save the Euro?
The buzzword of this inflation-ravaged era is more succinct. In fact, it’s just one word – ‘pivot.’
For our purposes it means the point at which the United States Federal Reserve will feel it can stop raising interest rates and begin to offer the possibility that they could start to go down.
It’s easy to see why that word dominates. 2022 brought, among other dark things, interest rate rises unprecedented in the working lives of many people now engaged with financial markets. The US central bank has hit the monetary brakes no fewer than seven times, pushing the benchmark rate up to a target range of 4.25-4.5%. That’s the highest rate in fifteen years. Moreover, while there are clear rhetorical signs that the Fed is now more cautious about raising rates than it was back in the summer, there are equally clear signals that borrowing costs will go higher yet and that it may not top out below 5%.
Given that the Fed Funds rate spent much of the time between 2009 and 2021 barely above zero, the scale of the turnaround has been astonishing.
And given that so many market participants cut their teeth in a long era of docile inflation, cheap money and ever-flowing credit, it’s no wonder that so many should be keen that the Fed does indeed pivot as soon as possible. The thing about Golden Ages is that people always want them back.
But that doesn’t mean they come back. Of course, the key to whether or not the Fed will, in fact, pivot, will be found in the inflation data. And the picture there is still very unclear.
Boosted by a number of factors, from the war in Ukraine through to Covid’s supply-chain havoc and a general rethink of the previously dominant trend toward ever-more globalization, prices surged in 2022 by measures not seen for fully 40 years. The US was not alone in facing this gale, of course. Other countries did so too, and some had it a lot worse. Inflation has run hotter in Europe thanks among other factors to its energy dependence on Russia.
Even Japan has seen a resurgence of pricing power, where inflation has been thought dead for decades.
But the US still runs the table, and it’s the success of the US response which will matter most. And there are some encouraging signs. The Fed’s preferred measure of inflation continued to slacken in November, providing another indicator that price pressures may indeed have peaked earlier in the year.
The Personal Consumption Expenditures price index, or PCE, rose 5.5% on the year, well below the 6.1% rise seen just a month earlier. The core measure, which cuts out the volatile effects of food and energy costs, was up by a more reassuring 4.7% annualized. Both readings were at their lowest since October 2021.
The release chimes with official Consumer Price Index data for the same month, which showed a similar slackening.
Nevertheless, price rises there still stand at 7.1%, which is a very long way indeed from the 2% rate targeted by the Fed. Moreover, the US central bank’s mandate is to promote stable prices and maximum employment. There may not be many active in the markets today who remember the inflationary pressures of the 1970s and early 1980s. However, there will be many in the Fed who do remember them, and how hard-won the victory was. The monetarist students at the US central bank will be only too aware that they can’t afford to end the rate rising process until inflation – and as importantly, inflation expectations – have been actually and obviously seen to be crushed.
Hence, we see things like stocks falling despite robust Gross Domestic Product numbers. Investors are seeing everything through the inflation prism, and any sign that the Fed’s action has yet to clearly cool economic activity just has investors ever-more convinced that the pivot is not here yet.
5.5% inflation may be better than 6.1%, but it’s still outrunning the Fed’s target by a huge amount, and there’s simply no way policymakers are going to stop fighting while that’s the case. Chair Jerome Powell and the rest of the Open Market Committee well know that their success in getting inflation down will define their time.
Many commentators think we might get very close to pivot territory by the late spring of next year, but in truth we’d probably have to see a marked moderation in wage momentum and, probably, employment growth. Both have remained surprisingly strong despite the Fed’s actions.
Inflation also has a nasty tendency to get sticky. Faced with rising prices, employees demand higher wages, which only add to cost pressures at a time when there’s usually little option but to pass these on again to consumers. And so on…
The upshot of all this is that it could yet be a very long time before the Fed actually does ‘pivot,’ and any prognosis that such a thing could happen in the early part of 2023 depends on evidence of a pretty rapid economic slowdown coming soon. If the economic data don’t start to support this thesis unambiguously in the early months of the year, then the waiting for the pivot could prove a much longer game than many in the markets now hope it’ll be.