The doves cooed from the depths of the Eccles Building yesterday, as the Federal Reserve left interest rates unchanged. The latest word is that Yellen & Co. are now worried about inflation running below their 2% target which, it should be noted, has been declining since March. (In stark contrast, we made the #Reflation'sRollover call earlier this year.)
So the Fed is way behind both market expectations of inflation and the actual economic data. Shocker.
What's Next: The Fed Will Go Hawkish
We think the Fed is missing the next big market move too. Here's analysis from Hedgeye CEO Keith McCullough in today's Early Look:
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"So, from the Fed’s perspective, what if:
From a Labor Economist’s (Janet Yellen) vantage point, each of those 3 things are hawkish on the margin. When you put all of them together, they’re outright hawkish vs. where the market is positioned (Down Dollar, Down Rates)." |
Unemployment ↓ = Wages ↑
The three things mentioned above are all part of the Hedgeye Macro team's call. Check out the Chart of the Day below that neatly lays out this relationship. What we're showing is the spread between U6 and U3 unemployment on the x-axis and wage growth on the y-axis.
The U3 rate is the headline unemployment rate quoted by media outlets. The most recent reading was 4.4%. The U6 rate includes what economists call "discouraged workers" – all persons marginally attached to the labor force – and the under-employed. That rate was most recently 8.6%.
When the U.S. economy is heating up the spread between U6 and U3 falls and average hourly earnings increases. This is an intuitive relationship that's born out by the data. Improving profit, productivity and investment growth should continue to support corporate hiring and a further tightening in the labor market, increasing the probability for accelerating wage inflation.
Bottom Line
If we're right that unemployment falls and wage inflation accelerates as GDP and company profits heat up, the Fed will be forced to go hawkish once again. Just like the Fed's dovish pivot yesterday on continually underwhelming inflation data, don't expect Yellen & Co. to sniff this out for another three to six months.
