Context of inflation in the United States and the process of rising rates
During the second half of last year, and in the midst of one of the most aggressive rate processes in the history of the world's first economy, inflation in the US began to give clear signs of slowdown. Importantly, the demand began to normalize its growth pace without reaching a stagnation point, much less contraction, and although job creation slowed down, it always remained at robust levels. To all the lights, it gave the impression that the Federal Reserve (FED) set the trajectory for the desire soft landing; A financial contraction that corrects inflation, but does not deepen enough to lead the economy to a recession.However, January I arrive with a given inflation that led to many to really reconsider that so close we find ourselves of an end in the rate subas cycle; both the general index and the core index recorded monthly increases around 0.6%, surpassing expectations of 0.5% and 0.4% respectively. Does this mean that the EDF continues without progressing its efforts? For nothing; like any number of inflation, it must be understood in its context. Paraphrasing Jerome Powell, President of the EDF, the consumption canast whose price determines PCE inflation (this is the index on which the objective of 2% annual is fixed) can be divided into 3 large areas: goods, housing-related services, and housing-related services.
The possibility of a "soft landing" in the American economy
The strong disinflation observed between July and December 2022 was exclusively linked to the component of goods, where prices accumulated a 1.2% drop. This can be given thanks to the decongestion of supply chains globally and a replacement of the consumption of goods for the consumption of services. It was hoped that the effects of normalization of transport would dissipate in time, and that a rebound in the consumption of goods would lead to price correction. And the acceleration in the given nucleus can be attributed almost exclusively to this; the index of goods went from an average monthly variation of -0.2% in the last 6 months to be located at 0.6% in January. It does not seem likely that this rhythm will remain beyond this point.The service area, on the other hand, has maintained for several months a much greater persistence; although it did not accelerate markedly in January, it remains at an average pace around 0.5% monthly 6 months ago. And this is where you have to put your eye.
Housing services are part of the problem, but it is estimated that they will soon cease to be. Returning to my previous note, we know that the increase in prices recorded in this area contains a strong delay, and is not illustrative of what currently occurs with the new lease contracts on the margin; according to the income index developed by a recognized Real Estate Marketplace, the new contracts fulfilled in January 4 consecutive months of falling prices. This indicates that, to the extent that old contracts end up incorporating the strong increases in previous months, they should tend to stagnate, contributing to the fall in the inflation data. In the words of Powell, the slowdown of rental services is “in tubes”, and we will soon see on the surface.
The area of the other services, which weighs 55% in the core PCE index, is the subject beyond, and today is the main source of concern for monetary policy makers. Here, you can't even see the slowdown, there are no indicators that we'll be seeing soon. While the goods sector is clearly intensive in the use of physical capital, the services sector not related to housing is distinguished by the use of human capital (absorb 86% of formal employees), and consequently we see here a close relationship between wages, unitary costs, and finally prices. And here the problem eye; for 10 months private wages for the service sector have grown at a constant rate and close to 0.4% a month, well above 0.2% which has been historically compatible with 2% inflation for the year. While private wages do not slow down their advance, we will hardly see a service price cooling, and core inflation would find a difficult floor to break.
The forced question is, why does it continue to increase wages so quickly? Returning to the basics, wages are a price like any other, and adjust to imbalances between supply and demand. If the demand for work by companies and companies does not find a sufficiently solid supply on the side of the workers, the excess demand for work takes its price until it returns to a balance. The arrival of the pandemic aggressively reached both demand and supply, leaving 25 million people unemployed, and leading another 17 million to withdraw from the labor force. Of course, the service sector absorbed the greatest impact, and in particular the services related to Ocio and Hospitality suffered more than anyone the paralysis of travel and tourism.
With the reopening of the world, the resurgence of demand comes, and the reopening of millions of jobs. People returned to the street with the clear goal of recovering the lost time, and consumption quickly burst into restaurants, tourism and leisure activities of all kinds. The job offer, on the other hand, began to return with Lag; after the enormous packages of fiscal stimulus launched during the encierro, a public who had not spent on anything had managed to bring his estate to very high levels, and now counted on a saving mattress that would appeal to him at any opportunity of work. The imbalance between a job demand that was forced to be reconstructed at a rapid rate and a more reticent population returning to the market was reflected in an unsustainable gap between vacancies and people willing to fill them; in March 2022, the number of vacancies opened was twice the unemployed population.
According to the latest information available, this gap still persists at the same levels. Although the rate of participation in the work (proportion of working-age people looking for, or already have, work) has recovered from the low levels of 2021, remains stagnant for months, still almost a point below the average of pre-pandemic. This means that the market today has 2.5 million people less looking for work. And when we look at the final impact on the amount of formal urban employees, we see that this figure is still markedly below what would indicate the trend of the 10 years before pandemic. So even with a job search that has not just recovered its pre-pandemic trail, the labour market is clear workers' deficit; the problem is on offer.
The following question is then that you are holding the labor force to return to your historical trend? When we analyze the labor participation of different demographic groups, there are two that jump in sight: the Latins/Hispanics, and the high-educational whites, over 55 years. While for the first the inactive force is above the pre-pandemic trend in about 1 million people, the second would almost fully explain the remaining 1.5 million inactive “extra”.
In any case, the interest rate does not seem the right tool to reverse this problem. Recovering work participation in a sector like Latin seems to demand another type of policies, which generate structural changes in labor inclusion. Pandemic was particularly hard for this group historically segregated for low-income jobs, especially vulnerable to systemic shocks, and with few opportunities for social mobility. The fall in participation was particularly acute among women, who face the massive closure of crèches during pandemic, are today with few options for the care of their children, and almost none of them is accessible.
On the other hand, the massive retreat of Baby boomers It also does not seem something that will reverse itself with a greater financial contraction; the phenomenal increase in savings rates that could be given in the context of pandemic allowed this group the dreamer “early retirement"; live from passive recipes. It doesn’t seem that 50 or 75 basic points more in the federal funds rate will make it feel a deterioration of their heritage that forces them to pack, abandon the beaches of Florida, and go back out in search of work.
So the problem is structural. To solve it, changes should also be structural. If policy does not recognize this and move towards an improvement in the incentive schemes for minorities, we cannot expect the labour supply deficit to be resolved in the medium term. And if we want to re-emit 2% inflation, using as the only tool monetary policy, the adjustment in the labour market will have to come on the demand side; a worsening outlook, an increase in financial costs, and a cooling of consumption that is sufficiently important to bridge the historical gap between vacancies and the unemployed. The key issue in this case will be the adjustment that will be seen in closing vacancies, and what will be seen in dismissals. And of course, that so compatible is this scenario with a soft landing.
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