Confirmation of “substantial progress” or not requires confirmation of the employment and inflation situation. However, there are still distortions and noise in the U.S. economic data. I believe that around September 2021, the temporary distortions in employment and inflation will be largely eliminated, so September is an important point to observe the current round of Fed decisions. By then the situation facing the Fed will be clearer, which will also allow the Fed to make a clearer decision on monetary policy.
On July 28, 2021, U.S. time, the Fed released the statement of its interest rate meeting. On the one hand, the statement argued that the U.S. economy has made progress toward its employment and inflation targets. But on the other hand, the statement from the rate meeting also confirmed that the Fed’s major monetary policies were unchanged and there were no changes in monetary policy coordination. At the same time, the mainstream market expectations for the Fed to open the exit process early next year also remained largely unchanged.
Then Fed Chairman Jerome Powell pointed out in an interview that “we’re still looking forward to further progress” and that “I think there’s still some distance to go to achieve the substantial further progress needed to achieve the maximum employment goal, and I’d like to see some strong employment data”.
Confirmation of “substantial progress” in the end, the employment and inflation situation needs to be confirmed. However, there is still distortion and noise in the U.S. economic data. There is also considerable disagreement among opinion leaders on employment and inflation indicators. I believe that the temporary distortions in employment and inflation will be largely eliminated around September 2021, so September is an important point to observe the current round of Fed decisions. By then the situation facing the Fed will be clearer, which will also allow the Fed to make a clearer decision on monetary policy.
The current Federal Reserve monetary policy orientation is unclear
Even stuck in a tangle
The current Fed QE withdrawal schedule is difficult to determine, mainly from the employment recovery there is greater uncertainty, the impact of high inflation is not the main problem for the time being.
Employment situation is not clear, which is the main uncertainty factors affecting the Fed’s QE exit time. First, the U.S. unemployment rate is significantly underestimated, considering the abnormal sharp decline in the labor force participation rate. If we take the labor force participation rate in February 2020 as the benchmark, the U.S. fixed labor force participation rate unemployment rate in June 2021 is still as high as 8.4%, significantly higher than the official unemployment rate (5.9%) released in the same period. The official unemployment rate may be a significant overestimate of progress in employment recovery. Non-farm payrolls still lost more than 6.7 million jobs in June compared to the pre-epidemic period, and it will still take about a year for non-farm payrolls to return to pre-epidemic levels if we take the monthly average of 540,000 new jobs in the first half of the year. However, the number of new nonfarm payrolls per month is extremely unstable, and there is a large uncertainty in the employment recovery process.
In the current U.S. labor market, under the high personal assistance policy, some low-income industries generally have a high unemployment rate, high job vacancy rate and high wage increase coexistence phenomenon. In the leisure and hospitality industry, for example, the average weekly wage in the industry was $483.1 in June, up 10.4% year-on-year, but still lower than the combined federal and state unemployment benefit rates, so the unemployment rate and job vacancy rate in the industry are both higher than average. As a result, the personal assistance may have seriously disrupted the price signals in the labor market and the policy implications of the unemployment rate as it should be.
The high inflation rate is also disrupted by temporary factors, specifically low prices in last year’s base period, low labor force employment intentions, supply chain tensions in segments such as chips and shipping, etc. The U.S. core CPI climbed to 4.5% in June, where there is a large base effect. If we use the two-year compound inflation rate, the core CPI actually came in at 2.7% in June. Here we do not calculate the core PCE, this is because the core PCE has not yet found the ringgit growth rate, so it is not possible to calculate the two-year caliber compound inflation rate. According to historical data, core PCE shows a systematic lower than core CPI. In other words, the core PCE growth rate should even be lower than 2.7% year-on-year in June. It can be seen that the lower base period factor has a significant perturbing effect on the inflation rate, especially the transportation item with the highest rate of increase is deeply affected by the base period factor.
In addition, the low willingness of labor force employment also makes the May-June U.S. service sector prices (excluding the caliber of rent) rose to about 4% year-on-year growth, much higher than the average level of less than 2% in the past 10 years. The low willingness of the labor force to be employed is related to the fact that vaccines are not fully available, schools are not in regular session, and the government is providing high levels of personal assistance. Obviously, these influences are also temporary in nature, and will recede once vaccines become widespread and the government ends personal assistance.
After these disruptive factors recede, inflationary pressures are expected to moderate. Moreover, in the normalization process of the labor force returning to work in large numbers, the demand and supply of the service sector will recover simultaneously, and the gap between supply and demand in the manufacturing sector will narrow significantly. Thus, the Fed’s insistence that high inflation is only temporary certainly has its basis. However, if the Fed still sees, and has reason to believe – after the vaccine is universal and the individual bailout is terminated – that inflation will remain high for a longer period of time, then the situation is more problematic.
What time of year will this situation be clearer? September.
September is an important time to watch the Fed’s monetary policy turn
The labor market is expected to normalize in September. Many of the factors currently limiting the labor force’s return to the market will recede in September and before. First, as of July 25, the number of vaccine doses per 100 people in the U.S. was 102, which is not yet the standard for universal immunization. As further vaccinations are administered, it will ease the fear of the virus in the workforce, potentially allowing some of the workforce to return to the market. Of course, there are some challenges to the effectiveness of the vaccine in the face of mutating viruses, although the existing vaccine remains highly effective in controlling severe disease rates and death rates. Secondly, with the normal start of school and resumption of classes in September, some of the workforce that has dropped out to care for families will return to the market. Finally, September is the deadline for the extended unemployment benefit policy, and the probability that the individual assistance policy will end against the backdrop of vaccine prevalence and fiscal spending pressures will also drive the labor force back into the market.
When the labor force’s willingness to work rises and reenters the labor market in large numbers, we expect we may see strange phenomena: on the one hand, the number of new jobs is rising, and on the other hand, the unemployment rate may rise. In the case of a rising labor force participation rate, these two points are perfectly consistent. In fact, this is already happening to some extent. in June 2021, already 22 states have successively eliminated unemployment benefits early. As a result, in that month, the number of non-farm payrolls in the United States added 850,000 while the unemployment rate edged up to 5.9%, a sign that the U.S. labor market is moving toward normalization.
The U.S. inflation situation will also become clearer in September. First, the base effect on high inflation will fade in the coming months. Second, the federal unemployment assistance policy will expire in September at the latest, and the fiscal policy to help inflation will gradually fade. Once again, after a large number of laborers return to the market, the supply-demand gap in the manufacturing sector is expected to ease, while the supply and demand in the service sector will rise simultaneously, and the overall inflation rate is expected to moderate in this context. In addition, the direction of movement of these forces will become clearer with regard to commodity prices, the epidemic and the extent and persistence of its impact on the supply chain.
Overall, around September this year, the labor market supply and demand in the U.S. will return to normalization, and some temporary distortions among inflation rates will recede. The real trade-off between employment and inflation faced by the Fed will also come out more clearly.
The Fed’s QE tapering is getting closer and closer
The Federal Reserve may release a clearer QE exit signal in September. The Fed is likely to start tapering QE at the end of 2021 to early 2022, according to the mainstream market view on the progress of the U.S. economic recovery and future outlook. although the specific timing of the Fed’s QE tapering is uncertain, the situation will become clearer in September. The Fed may reveal more information about QE exit at the September rate meeting. If the employment recovery significantly exceeds expectations, the Fed may even provide more new clues as early as August at the annual meeting of the Jackson Hole Global Central Bank.
But more likely, the U.S. will still be in the process of digesting the pressure of rising labor force participation rate by then. The rise in the labor force participation rate will lead to substantial improvement in employment, but will slow down the improvement process of the unemployment rate indicator. The supply and demand in the U.S. labor market may return to normal to a greater extent in September, which will also make the unemployment rate and its direction of change more informative.
However, there are also disturbing factors in the Fed’s QE exit path. First, if the employment recovery is less than expected, the Fed’s QE exit time will be regenerated variables. Secondly, if the Fed in communication with the market QE exit problem, the financial markets shake dramatically, the Fed may also be forced to reconsider the QE exit point.
Finally, according to the CDC data, more than 80% of the recent new cases in the United States are infected with the mutated Delta strain. Currently, about 50% of the U.S. population has completed vaccination, and some concentrated areas and concentrated populations have not yet been vaccinated, and the rate of vaccination continues to decline, which may allow the Delta strain to continue to mutate and spread, and affect the opening of the U.S. economy and economic recovery, and thus affect the Fed’s adjustment of monetary policy. The epidemic, remains the greatest uncertainty for the U.S. economy and the global economy.