In a press conference dominated again by financial stability concerns, there was little room for the real side and inflation. The 25bps hike came as no surprise, given that the terminal rate suggested by our simulations using FRB-US and the Fed staff (2021) Taylor rule remains a bit above the current rate. We remain unsure whether this is the last hike of this cycle because, as Powell said, “the process of getting inflation back down to 2% has a long way to go”. Next week we will have CPI. If the Fed is now truly “data dependent”, what will happen at the June meeting, should we get a 0.4%-0.5% core CPI in April and May?
We review two Q&As, one obvious and the other puzzling.
Q&As
Question. Are wages above the level consistent with the 2% target? How do you come to that judgment?
Powell. “We look at a range of wage measures. It’s a nominal [measure] so you assume wages should be equal to productivity increases plus inflation. […] Three percent is closer to where they need to be”
Comment: What Powell said is simply the traditional wage decomposition. The chart below shows the ECI (Q4/Q4) decomposition (that is the contributions to the ECI growth rates) that we include in our Pre-FOMC meeting package. Powell’s answer implies, as we also estimated, that the Fed staff is putting structural productivity at about 1¼ percent. Please, get in touch if you have questions about the below ECI decomposition.
Figure 1. Contributions to ECI (Q4/Q4) wage growth
Question. Profit margins have expanded but they are now declining. Do you see corporate profits as a driver of inflation and do you expect them to narrow and contribute to reduce inflation in the coming months?
Powell. “Profit margins are what happens when you have an imbalance between supply and demand: too much demand, not enough supply. And we’ve been in that situation in many parts of the economy where supply has been fixed or not flexible enough, and so you know… the way the market clears is through higher prices. I think as goods pipelines have gotten, you know.. back to normal so that we don’t have the long waits and the shortages and that kind of thing, I think you will see inflation come down and you’ll see corporate margins coming down as a result of a return of full competition where there’s enough supply to meet demand, that’s that would be the dynamic I would expect”.
Comment: We are not sure there is robust evidence behind Powell’s words and we are not sure we can count on declining margins to moderate inflation (maybe only in a couple of sectors) going forward. The reason is shown in Figure 2, which shows the contributions of unit labor cost, unit non labor cost, and unit profits to the change of price per unit of real gross value added of nonfinancial corporate business sector. Data come from NIPA table 1.15. We are aware of the limitations of the data (measurement issues, possible reverse causality, etc..) but, if anything, the evidence of the last two quarters goes against what Powell said (and it is in line with the question received). We leave the reader a provocative question? Are we sure we can count on reduced profit margins to disinflate the US economy? We are not.
Figure 2. Contributions to the change of price per unit of real gross value added of nonfinancial corporate business sector (NIPA table 1.15).
