Financial Insights

The Fed Looks Ahead

The Fed’s interest rate hike seems entirely appropriate in anticipation of the scarcity of labor creating upward pressure on labor costs and inflation.  Notably, actual inflation has moderated ever so slightly.  Most members of the Fed seem inclined to trust the economic theory, while its critics, including Minneapolis Fed President Kashkari, are inclined to wait for evidence of higher inflation before accepting the need for higher interest rates.  Such an approach seems overly risky, the Fed’s decision seems justifiable and more such steps should be each quarter.

There’s no doubt that the labor market has become tight, but inflation has remained fairly well behaved, at least so far.  But, how long can this last?  Every measure of the labor market, including the unemployment rate, job openings, initial unemployment claims, and everything else shows a scarcity of labor.  So, it is mystifying that labor costs haven’t increased meaningfully more than seen so far.  It seems likely that average hourly wages are statistically depressed because low wage, less skilled workers account for so much of the hiring, which drags down the average.  The average is also reduced by the retirement of massive numbers of baby boomers and the entry of younger workers who earn far less.  Adjusted for the changing mix of workers, as in the Employment Cost Index, suggests a faster rate of wage inflation.  But this report is released just quarterly, so it garners less attention.  But the second stage of this process, higher cost of labor flowing into prices, also needs to become apparent.  Theory suggests it should happen.

The Fed’s policy decisions over the past two years implied a willingness to keep interest rates low, because it didn’t think unemployment was low enough to promote higher labor costs.  Evidently, that’s no longer the case.  With unemployment already at 4.3% and job growth continuing, even if a bit more slowly, the Fed no longer sees room for unemployment to decline without exerting greater pressure on wages and inflation.  In fact, it was our judgment the Fed should have started the process of normalizing interest rates sooner.  We should soon see, over the course of the year, if the Fed should have started sooner, if the Fed’s time table is correct, or if the Fed’s critics are right.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

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