Sources and Notes: Cetera Investment Management, Federal Reserve Bank of St. Louis, FactSet, Morningstar, U.S. Bureau of Labor Statistics (Monthly Jobs Growth, Unemployment Rate, Labor Force Participation Rate, Consumer Price Index, Core CPI, Producer Price Index, Average Hourly Earnings), U.S. Employment and Training Administration (Initial Jobless Claims), Treasury Department (Treasury Yield Curve), Chicago Board Options Exchange (Volatility Index), LME (Copper), The Baltic Exchange (Baltic Dry Index). The color purple indicates the data is strengthening and gray indicates the data is weakening. The Fed-O-Meter is the opinion of Cetera Investment Management based on interpreting the data in relation to the Federal Reserve's public statements and official releases. It is meant for discussion purposes only.
Monthly jobs growth that is consistently strong, while pushing total employment closer to the pre-pandemic peak is hawkish (less need for the Fed to stimulate the economy), whereas weak employment growth is dovish because it is a sign of weakening demand for labor in the economy.
An unemployment rate that is falling and approaching pre-pandemic levels (under 4%) is hawkish because it signals the labor market is nearing the Fed's goal of maximum employment. A rising unemployment rate is dovish because the economy likely needs additional monetary stimulus to spur economic growth.
Initial jobless claims that are trending lower is hawkish because fewer people are losing their jobs, pointing to a healthy labor market and a lower need for the Fed to keep interest rates low. A rise in initial jobless claims is dovish because it is a sign the economy is weakening, and a precursor to higher unemployment (more need for Fed to provide monetary stimulus).
Labor force participation of the working age population (25-54 yrs.) is an indicator that shows the breadth of the labor market recovery. It is hawkish when it rises because more people are participating in the labor force (less need for Fed support) and dovish when it is trending lower (a sign the economy needs Fed support).
A rising Consumer Price Index (CPI) signals inflationary pressure for consumer goods and services. Low or falling consumer price growth is dovish because the economy needs stimulus to reach stable and moderate inflation, whereas persistently higher consumer price growth is hawkish because there is an increased need for the Fed to raise interest rates to stabilize inflation.
Core CPI is the consumer price index excluding food and energy because their price fluctuations can be volatile. Low or falling core consumer price growth is dovish because the economy needs stimulus to reach stable and moderate inflation, whereas persistently higher core consumer price growth is hawkish because there is an increased need for the Fed to raise interest rates to stabilize inflation.
The Producer Price Index (PPI) measures inflation using input costs for producers. Low or falling PPI growth is dovish because weaker input costs for producers place less inflationary pressure on consumer price growth (goal of the Fed is moderate inflation). Rising or elevated PPI often gets passed to the consumer with higher prices and that is hawkish because there is an increased need for the Fed to raise interest rates to stabilize inflation.
Wage growth is measured as the change in average hourly earnings over the last 12 months. Low or stable wage growth is dovish and rising or elevated wage growth is hawkish because it can put upward pressure on consumer prices, which increases the likelihood of the Fed raising rates.
The Treasury Yield Curve measures the yield difference between the 10-year and 2-year Treasury yield. If the yield gap is declining, the bond market is projecting a weaker outlook for economic growth and inflation which is dovish. A widening yield curve is indicative of higher economic growth and inflation prospects from bond investors which is hawkish because an overheating economy and rising inflation can result in the Fed raising interest rates.
The CBOE Volatility Index (VIX) is a measure of stock market volatility based on options pricing. A rise in the VIX could signal that equity markets anticipate a more hawkish Fed, driving market volatility higher. A declining VIX can signal less concern from equity investors about a near-term rise in interest rates.
The price of copper is viewed as a proxy for the strength of the economy. While the Fed wouldn't raise rates directly because of copper prices, they are more likely to become more hawkish if the economy is overheating and more likely to be more dovish if the economy is weakening.
The Baltic Dry Index measures the cost to ship industrial materials and is viewed as a barometer for future economic growth prospects. It is hawkish if the Baltic Dry Index is high and rising because it means the economy is strong and inflationary pressures are increasing from higher shipping costs. It is dovish if the Baltic Dry Index is falling because the outlook for economic growth is easing and shipping costs are declining (lower inflation risk).
As we enter the next phase of the expansion, the focus will shift from metrics aimed at the initial recovery to metrics the Federal Reserve is looking at to gauge the health of the economy. Since the Fed’s dual mandate is to keep prices stable and maximize employment, we will focus on labor and inflation metrics, keeping in mind the broader economic impact as well. We created a Fed Monitor to track some of the data points that will impact the Fed’s decisions to tighten financial conditions. Additionally, we try to quantify the data and information outside of the dashboard to determine if the Fed is being more dovish than the data, and likely to be more aggressive in the future, or if they are being hawkish relative to the data, and likely to be more conservative in the future.
Inflation surged above expectations in October. U.S. consumer prices rose last month at the fastest annual pace in three decades as inflationary pressures spread throughout the economy. Driving the increase was an uptick in costs for energy along with shelter, food and cars. Following the report, the first Fed rate hike is now expected as early as June according to traders in the futures markets. CME Group’s FedWatch Tool now projects a 55% chance of at least one rate hike by June 2022.
Along with continuing inflation, America’s labor recovery also picked up steam last month as U.S. employers added 531,000 positions in October. Following two months of sluggish job gains, October’s report helped relieve concerns that a labor shortage and slowing economic growth would hamper job creation. Earlier this month, the Fed said job growth is strengthening enough for the central bank to begin scaling back its monthly bond purchases. The Fed is expected to complete its bond buying tapering before raising interest rates.
We currently think the Fed is being cautious when looking at increasingly hot economic data. Another strong month of the recovery may force officials to speed up the pace of their tapering program. We continue to believe inflation will be less transitory, and the Fed will be forced to raise rates sooner than it is currently projecting.