FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 15, 2022

IN THIS ISSUE:

1. Overview – Inflation & the Fed Dominate the Headlines

2. U.S. Inflation Jumps To 40-Year High in January – Why?

3. Fed Big-Shot Calls For Much Bigger Initial Rate Hike

4. The Huge January Jobs Report Requires A Closer Look

Overview – Inflation & the Fed Dominate the Headlines

Some weeks, it can be hard to find a topic I think is really interesting to write about. Then there are other weeks when so much is happening I don’t know where to start. This is one of those weeks. If I had to pick a theme which has been hogging the spotlight recently it would be rising inflation and the reactions to the highest level of price increases we’ve seen in 40 years.

As everyone reading this knows, the Fed is virtually certain to raise short-term interest rates at its upcoming policy meeting in March and most likely at the next several meetings after that. The only question now is how high the Fed will have to hike rates to get inflation under control – and that is a question subject to a great deal of debate. So, that’s what we’ll focus on today.

I also want to take us back to the unemployment report for January which was released on Friday, February 4 showing a whopping 467,000 new jobs created, which was a giant surprise, as I will discuss below. Economists and forecasters were stunned.

Well as it turns out, the Labor Department made some substantial changes to the models it uses to track job creation, and those changes resulted in the huge job growth we saw for January. You need to know about this. Let’s get started.

U.S. Inflation Jumps To 40-Year High in January – Why?

I think it’s safe to say we’ve all been at least a little surprised by how much US inflation has risen over the last year or so, and especially in the last couple of months. After hovering around 2.0-2.5% on average over the last decade or longer, the Consumer Price Index has soared over the last year. It has been the fastest rise in inflation since the late 1970s.

Inflation soared over the past year at its highest rate in four decades, hammering America’s consumers, wiping out pay raises and reinforcing the Federal Reserve’s decision to begin raising borrowing rates across the economy.

The Labor Department said Thursday that consumer prices jumped at an average annual rate of 7.5% last month, the steepest year-over-year increase since February 1982. Shortages of supplies and workers, heavy doses of federal aid, ultra-low interest rates and robust consumer spending combined to send inflation accelerating in the past year.

There are few signs inflation will slow significantly anytime soon. Most of the factors that have forced up prices since last spring remain in place. Wages are finally rising rapidly. Ports and warehouses are overwhelmed, with hundreds of workers at the busiest ports of Los Angeles and Long Beach and others, out sick last month. Numerous ports on the East Coast are stretched as well. Many products and parts remain in short supply as a result.

The steady surge in prices has left many Americans less able to afford food, gas, rent, childcare and other necessities. More broadly, inflation has emerged as the biggest risk factor for the economy and as a serious threat to President Joe Biden and congressional Democrats as midterm elections loom later this year.

The Fed and its chair, Jerome Powell, have pivoted sharply away from the ultra-low-interest rate policies that the Fed pursued since the pandemic devastated the economy in March 2020. Powell signaled last month the central bank would almost certainly raise its benchmark short-term rate multiple times this year, with the first hike likely coming in March. Based on Fed Funds futures, investors have priced in four to five rate increases in 2022.

Fed Big-Shot Calls For Much Bigger Initial Rate Hike

The Fed Open Market Committee (FOMC) which sets monetary policy typically meets eight times per year. The next FOMC meeting is scheduled for March 15-16 followed by additional meetings on May 3-4, June 14-15 and July 26-27. If the March meeting goes as widely expected, the Fed will announce it is raising its Fed Funds rate from 0.00%-0.25% to 0.25%-0.50%.

The announcement will come in the Fed’s official policy statement released at the end of its meeting on March 16 at 2:00 PM EST. The increase will come as a surprise to no one. However, what may be a surprise on March 16 is the size of the rate increase.

For the last couple of months, it has been widely assumed the central bank will raise the Fed Funds rate by 25 basis points (0.25%). The Fed historically raises its key rate in increments of 25 basis points with each move in what it describes as a “measured pace.” No surprises.

However, the Fed has in the past occasionally raised its benchmark interest rate by 50 basis point (0.50%) in a single move, although not in recent years. Such a move had not been contemplated by the markets… at least not until last week.

On Thursday of last week, James Bullard, President of the Federal Reserve Bank of St. Louis (and member of the FOMC), surprisingly called for a 50-basis point increase in the Fed Funds rate at the March 15-16 policy meeting, largely as a result of the higher than expected CPI reading for January. This caught the financial markets off-guard bigtime.

Furthermore, Bullard also recommended the Fed Funds rate be hiked another 25 basis points at the May 3-4 and June 14-15 FOMC meetings – for a total of 1% over the next several months. While Bullard is just one of 12 members of the FOMC, his comments came as a negative surprise to the financial markets and stocks traded decidedly lower in response.

I should note that several other members of the FOMC spoke out just after Bullard’s comments and essentially said they did not agree with a 50 basis point hike on March 16, but the futures markets quickly reflected such a larger increase than had been previously expected.

Economists at Citibank and some other Wall Street banks joined the chorus and upped their forecasts for a rate increase of 50 basis points on March 16. I tend to doubt the Fed will hike rates by 50 basis points in March because Fed Chair Powell has repeatedly said recently the Fed will raise rates at a ”measured pace.” We’ll know soon enough, but it is an interesting development.

The Huge January Jobs Report Requires A Closer Look

As noted earlier, I want to take us back to the jobs report for January which was released on Friday, February 4 showing a whopping 467,000 new jobs created, when in fact most forecasters had predicted a loss of 150,000-200,000 or more last month. What a surprise! It was one of the biggest pre-report misses I have seen in a very long time.

But as usual, a deeper dive into the data reveals there was a key reason for this big overshoot.  Here's the scoop. January happens to be the month when the Labor Department does an annual update of many of its forecasting models. With updated population data from the US Census Bureau, they're able to generate new and better estimates on new jobs created.

And here’s the point: The huge January jobs gains came entirely from these Census changes.

Read that again, let it soak in. All  those 467,000 new jobs reported for January were the result of changes to the Census Bureau’s forecasting models. Of course, few in the media reported this fact.

Without the adjustment for the new Census data, the economy actually lost jobs in January 2022. Thanks to the adjustment, gains that took place in previous months showed up in January's report. So, it’s not as if those jobs aren’t real, they are. They just didn’t all show up in January as the report would have us believe.

Again, this was one of the biggest pre-report forecast misses I have seen in a long, long time. The Biden administration wasted no time taking full credit for it (of course, Republicans would have done the same thing if they were in charge).

Just to be clear: the 467,000 new jobs are real; they just didn’t all show up in January as the report suggested. They were created throughout last year in bits and pieces over the months.

Best personal regards,

Gary D. Halbert

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