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).
The economic expansion has advanced from the initial recovery, and the focus is now on 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.
Fed Chair Jerome Powell sent a strong message to markets at the Jackson Hole Economic Symposium in late August. Powell’s brief speech focused on the Fed’s need to stay the course to bring down inflation from 40-year highs, even if higher for longer rates causes a recession. Powell reaffirmed these views during the September post- FOMC press conference. The bigger risk, in the Fed’s view, is loosening monetary policy too soon, allowing inflation to remain elevated for a longer stretch. Ultimately, they don’t want to repeat the mistakes made during the 1970s, when the Fed would prematurely cut rates, allowing elevated inflation to persist for more than a decade. The Fed hiked rates by 0.75% at this month’s FOMC meeting, bringing the Fed Funds rate to a range of 3.0% to 3.25% (highest since early 2008). The closely watched dot plot projections point to a more aggressive rate hike path than previously indicated in the last dot plot release in June. The median rate projection for year-end increased from 3.4% to 4.4%. Looking ahead to 2023, the median rate projection rose from 3.8% to 4.6%.
The economic data gives the Fed some leeway to maintain higher rates. The jobs market remains healthy, though aggressively raising rates may have a lagged effect on the labor economy. Wage growth is also edging slightly lower, which may help lessen inflationary pressures. Inflation is the Fed’s primary focus right now and the August consumer price index (CPI) release showed that inflation rose higher than expected last month. Core CPI, which excludes volatile food and energy categories, increased 0.6% month-over-month, double the consensus forecast from economists. Headline CPI also rose slightly faster than expected. Core CPI increased 6.3% year-over-year in August, accelerating from 5.9% in July. The producer price index (PPI), on the other hand, declined month-over-month in July and August, indicating that input costs for businesses are weakening. There are additional indicators that may point to inflation easing in the months ahead. Wholesale used car prices are falling, key food commodity prices have come down, ocean freight shipping costs are down markedly this year, and rent growth data is softening. Moreover, the prices paid components of the ISM manufacturing and services PMI indicate easing price pressures.
We are maintaining the Fed-O-Meter dial slightly to the right of the middle. Year-over-year inflation is still far above the Fed’s long-term target of 2.0% and the labor market is still strong. Through year-end, the Fed is signaling that interest rates will rise above 4%. The Fed continues to reiterate they are data dependent, so they could pivot if data on inflation reverses faster than expected next year.