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The Fed should stand pat on further interest rate hikes at this week’s meeting: Inflation is easing even as the labor market remains strong

Inflation and all of its main drivers sharply decelerated in the last half of 2022. This was the case even though the pace of economic growth accelerated…



Inflation and all of its main drivers sharply decelerated in the last half of 2022. This was the case even though the pace of economic growth accelerated in the second half of the year and unemployment remained very low.

The Federal Reserve’s “dual mandate” is meant to balance the risks of inflation versus the benefits of fast growth and low unemployment. Right now, the benefits of low unemployment are enormous, and the risks of inflation are retreating rapidly. If the Fed lets the current recovery continue apace by not raising interest rates further at this week’s meeting, 2023 could turn out to be a great year for the economic fortunes of American families.

It is time for the Fed to stand pat on interest rate increases and wait to see how the lagged effects of past increases enacted in 2022 will filter through to the economy. Continuing to raise rates in the early stretches of 2023 will be a clear mistake and pose an unneeded threat to growth in the next year. In particular, the Fed should note the following:

  • Rapidly decelerating inflation in the last quarter of 2022 happened even in the absence of a strong disinflationary effect everybody knows is coming quickly in 2023: falling housing cost inflation.
  • Wage growth is normalizing quickly—average wage growth for the last three months of 2022 relative to the previous three months was just 4.3% at an annualized rate. This is down from a peak growth rate of 6.1% seen earlier in 2022.
    • Crucially, this proves that wage growth can normalize without a steep rise in unemployment. This should settle one of the key debates over monetary policy going forward.
  • Corporate profit margins—one of the key drivers of inflation—will likely stabilize or even contract in the coming year. This means labor’s share of income will rise, which has the potential to absorb any wage growth that exceeds its long-run targets for years to come. Past experience suggests strongly that this is not just a vague hope, but will actually happen.

Housing costs are the shoes that haven’t dropped yet

Much of the acceleration in core inflation seen in late 2021 and 2022 was in housing. However, even as overall core inflation decelerated strongly in the last quarter of 2022, housing costs did not. That is changing—all close observers of real estate markets are flagging industry data that show beyond any real doubt that housing cost inflation (both prices of homes and rental costs) is falling rapidly.

However, because of well-known issues in how housing costs are measured and reported in official government price indices, this lower inflation will not be seen in official data until later in 2023. But they are all but guaranteed to show up.

Figure A below, for example, shows the tight fit between one often-cited industry measure of housing prices (the Case-Shiller home price index) lagged one period and the current reading of shelter inflation in the Consumer Price Index. The tight fit between these measures shows, for example, that developments in the Case-Shiller index in 2022 are likely to predict shelter inflation in 2023. Because this relationship indicates that a dose of significant disinflation is clearly in the pipeline even as overall inflation measures are normalizing, the Fed should feel far more comfortable standing pat on further rate hikes.

Figure A

Wage growth has normalized quickly

A key concern of inflation hawks over the past year has been rapid growth in nominal wages. They have called attention to the relatively uncontroversial fact that an overall price inflation target of 2% is consistent with nominal wage growth of only about 3.5% when the economy is in equilibrium, and that this wage growth has been as high as 6.1% in 2022. However, there are plenty of reasons why this is misleading about the threat that fast nominal wage growth might pose to inflation today.

For one, wage growth has been decelerating rapidly. In the last three months, annualized wage growth has been running at a 4.3% (annualized) rate, a pace consistent with inflation below 3%. This represents a sharp deceleration even as the unemployment rate has remained very low.

Figure B below shows the unemployment rate and the three-month change (expressed as an annualized rate) of wage growth in recent years. The dashed lines smooth out the extreme ups and downs of both unemployment and wage growth during the pandemic recession and early recovery. (In the case of wage growth, these extreme ups and downs were largely due to compositional effects that gave very little information about the actual state of labor market tightness one way or the other.)

Figure B
Figure B

Falling corporate profit margins will put further downward pressure on prices in 2023

The claim that 3.5% wage growth is the fastest rate consistent with 2% inflation “in equilibrium” assumes that the share of overall income claimed by workers’ pay rather than corporate profits remains constant. However, wage growth can exceed 3.5% for a spell of time while still being consistent with 2% inflation if the labor share of income is allowed to rise. Importantly, the labor share of income has shrunk significantly throughout the recovery from the COVID-19 recession. This means that by definition the economy is not in equilibrium on this score, and just returning to the pre-COVID labor share of income would allow lots of wage growth without feeding through to price inflation.

This is, of course, the mirror image of saying that rising corporate profit margins have been a prime driver of inflation throughout this business cycle, but these margins will stabilize or even contract in the coming year, clearing the way for non-inflationary wage growth.

Some have argued that, while arithmetically true, claims that a rising labor share of income will absorb some of the inflationary impact of faster wage growth are just wishful thinking. Empirically, that’s flat-out wrong. In essentially every single business cycle since World War II, when unemployment moved close to pre-recession levels late in recoveries, further labor market tightening has been strongly associated with a rising labor share of income. This means that the rising labor share absorbed lots of potential inflation and kept it from happening.

Figure C below shows the slightly complicated cyclical dynamics of the labor share of income over business cycles. Its local peak occurs during recessions, as profits fall faster than wage incomes in the recessionary phase of the business cycle. But the labor share trough tends to follow quickly after its recessionary peak, and the latter stages of business cycles universally show a rapid rise in the labor share. Sometimes this labor share increase is snuffed out by another recession before it regains its previous peak, but the pattern is very clear: As labor markets remain relatively hot, much of the potential inflationary impact of this tight labor market is absorbed by a rising labor share of income. This post provides some regression evidence that further labor market tightening is associated with labor share increases.

Figure C
Figure C

Just how much room do we have from potential labor share increases to absorb wage increases without generating upward pressure on inflation? Figure D below shows how long the pace of wage growth seen in the last quarter of 2022 could be sustained with inflation rising at 2% and the labor share of income reaching the pre-recession peaks it saw in 2019, 2007, and 2000, respectively.

Essentially, this figure shows that labor share peaks seen in the past few business cycles provide many years of room for wages to grow as fast as they are currently without pushing inflation above the Fed’s 2% target. If we use 2019 as the benchmark, we could see current wage growth being fully absorbed by a rising labor share until the second half of 2026. If 2007 is the benchmark, this can happen until the end of 2029. Finally, if 2000 is our benchmark, wage growth at its current pace is possible without seeing inflation above 2% all the way until the end of 2036.

Figure D
Figure D


The balance of risks faced by the Fed has moved decisively away from spiraling inflation. Key sources of disinflation—especially housing costs and a rising labor share of income—have yet to kick in, and inflation still decelerated rapidly in the last quarter of the year. The Fed should stand pat on interest rate increases. If they instead insist on raising rates, this will pose a dire threat to what could be an excellent 2023 for the economic prospects of America’s working families.

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Lower mortgage rates fueling existing home sales

To understand why we had such a beat in sales, you only need to go back to Nov. 9, when mortgage rates started to fall from 7.37% to 5.99%.



Existing home sales had a huge beat of estimates on Tuesday. This wasn’t shocking for people who follow how I track housing data. To understand why we had such a beat in sales, you only need to go back to Nov. 9, when mortgage rates started to fall from 7.37% to 5.99%.

During November, December and January, purchase application data trended positive, meaning we had many weeks of better-looking data. The weekly growth in purchase application data during those months stabilized housing sales to a historically low level.

For many years I have talked about how rare it is that existing home sales trend below 4 million. That is why the historic collapse in demand in 2022 was one for the record books. We understood why sales collapsed during COVID-19. However, that was primarily due to behavior changes, which meant sales were poised to return higher once behavior returned to normal.

In 2022, it was all about affordability as mortgage rates had a historical rise. Many people just didn’t want to sell their homes and move with a much higher total cost for housing, while first-time homebuyers had to deal with affordability issues.

Even though mortgage rates were falling in November and December, positive purchase application data takes 30-90 days to hit the sales data. So, as sales collapsed from 6.5 million to 4 million in the monthly sales data, it set a low bar for sales to grow. This is something I talked about yesterday on CNBC, to take this home sale in context to what happened before it. 

Because housing data and all economics are so violent lately, we created the weekly Housing Market Tracker, which is designed to look forward, not backward.

From NAR: Total existing-home sales – completed transactions that include single-family homes, townhomes, condominiums and co-ops – vaulted 14.5% from January to a seasonally adjusted annual rate of 4.58 million in February. Year-over-year, sales fell 22.6% (down from 5.92 million in February 2022).

As we can see in the chart above, the bounce is very noticeable, but this is different than the COVID-19 lows and massive rebound in sales. Mortgage rates spiked from 5.99% to 7.10% this year, and that produced one month of negative forward-looking purchase application data, which takes about 30-90 days to hit the sales data.

So this report is too old and slow, but if you follow the tracker, you’re not slow. This is the wild housing action I have talked about for some time and why the Housing Market Tracker becomes helpful in understanding this data.

The last two weeks have had positive purchase application data as mortgage rates fell from 7.10% down to 6.55%; tomorrow, we will see if we can make a third positive week. One thing to remember about purchase application data since Nov. 9, 2022 is that it’s had a lot more positive data than harmful data. 

However, the one-month decline in purchase application data did bring us back to levels last seen in 1995 recently. So, the bar is so low we can trip over.

One of the reasons I took off the savagely unhealthy housing market label was that the days on the market are now above 30 days. I am not endorsing, nor will I ever, a housing market that has days on the market at teenager levels. A teenager level means one of two bad things are happening:

1. We have a massive credit boom in housing which will blow up in time because demand is booming, similar to the run-up in the housing bubble years.

2. We simply don’t have enough products for homebuyers, creating forced bidding in a low-inventory environment. 

Guess which one we had post 2020? Look at the purchase application data above — we never had a credit boom. Look at the Inventory data below. Even with the collapse in home sales and the first real rebound, total active listings are still below 1 million.

From NAR: Total housing inventory registered at the end of February was 980,000 units, identical to January & up 15.3% from one year ago (850,000). Unsold inventory sits at a 2.6-month supply at the current sales pace, down 10.3% from January but up from 1.7 months in February ’22. #NAREHS

However, with that said, the one data line that I love, love, love, the days on the market, is over 30 days again, and no longer a teenager like last year, when the housing market was savagely unhealthy.

From NAR: First-time buyers were responsible for 27% of sales in January; Individual investors purchased 18% of homes; All-cash sales accounted for 28% of transactions; Distressed sales represented 2% of sales; Properties typically remained on the market for 34 days.

Today’s existing home sales report was good: we saw a bounce in sales, as to be expected, and the days on the market are still over 30 days. When the Federal Reserve talks about a housing reset, they’re saying they did not like the bidding wars they saw last year, so the fact that price growth looks nothing like it was a year ago is a good thing.

Also, the days on market are on a level they might feel more comfortable in. And, in this report, we saw no signs of forced selling. I’ve always believed we would never see the forced selling we saw from 2005-2008, which was the worst part of the housing bubble crash years. The Federal Reserve also believes this to be the case because of the better credit standards we have in place since 2010. 

Case in point, the MBA‘s recent forbearance data shows that instead of forbearance skyrocketing higher, it’s collapsed. Remember, if you see a forbearance crash bro, hug them, they need it.

Today’s existing home sales report is backward looking as purchase application data did take a hit this year when mortgage rates spiked up to 7.10%. We all can agree now that even with a massive collapse in sales, the inventory data didn’t explode higher like many have predicted for over a decade now.

I have stressed that to understand the housing market, you need to understand how credit channels work post-2010. The 2005 bankruptcy reform laws and 2010 QM laws changed the landscape for housing economics in a way that even today I don’t believe people understand.

However, the housing market took its biggest shot ever in terms of affordability in 2022 and so far in 2023, and the American homeowner didn’t panic once. Even though this data is old, it shows the solid footing homeowners in America have, and how badly wrong the extremely bearish people in this country were about the state of the financial condition of the American homeowner.

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SVB contagion: Australia purportedly asks banks to report on crypto

Australia’s prudential regulator has purportedly told banks to improve reporting on crypto assets and provide daily updates.



Australia’s prudential regulator has purportedly told banks to improve reporting on crypto assets and provide daily updates.

Australia’s prudential regulator has purportedly asked local banks to report on cryptocurrency transactions amid the ongoing contagion of Silicon Valley Bank’s (SVB) collapse.

The Australian Prudential Regulation Authority (APRA) has started requesting banks to declare their exposures to startups and crypto-related companies, the Australian Financial Review reported on March 21.

The regulator has ordered banks to improve their reporting on crypto assets and provide daily updates to the APRA, the Financial Review notes, citing three people familiar with the matter. The agency is aiming to obtain more information and insight into banking exposures into crypto as well as associated risks, the sources said.

The new measures are apparently part of the APRA’s increased supervision of the banking sector in the aftermath of recent massive collapses in the global banking system. On March 19, UBS Group agreed to buy its ailing competitor Credit Suisse for $3.2 billion after the latter collapsed over the weekend. The takeover became one of the latest failures in the banking industry following the collapses of SVB and Silvergate.

Barrenjoey analyst Jonathan Mott reportedly told clients in a note that the situation “remains stable” for Australian banks but warned confidence could be quickly disrupted, putting pressure on bank margins.

Related: Silvergate, SBV collapse ‘definitely good’ for Bitcoin, Trezor exec says

“Our channel checks indicate deposits are not being withdrawn from smaller institutions in any size, and capital and liquidity buffers are strong,” Mott said, adding:

“But this is a crisis of confidence and credit spreads and cost of capital will continue to rise. At a minimum, this will add to the margin pressure the banks are facing, while credit quality will continue to deteriorate.”

The news comes soon after the Australian Banking Association launched a cost of living inquiry to study the impact of the COVID-19 pandemic and geopolitical tensions on Australians. The inquiry followed an analysis of the rising inflation suggesting that more than 186 banks in the United States are at risk of a similar shutdown if depositors decide to withdraw all funds.

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Delta Move Is Bad News For Southwest, United Airlines Passengers

Passengers won’t be happy about this, but there’s nothing they can do about it.



Passengers won't be happy about this, but there's nothing they can do about it.

Airfare prices move up and down based on two major things -- passenger demand and the cost of actually flying the plane. In recent months, with covid rules and mask mandates a thing of the past, demand has been very heavy.

Domestic air travel traffic for 2022 rose 10.9% compared to the prior year. The nation's air traffic in 2022 was at 79.6% of the full-year 2019 level. December 2022 domestic traffic was up 2.6% over the year-earlier period and was at 79.9% of December 2019 traffic, according to The International Air Transport Association (IATA).

“The industry left 2022 in far stronger shape than it entered, as most governments lifted COVID-19 travel restrictions during the year and people took advantage of the restoration of their freedom to travel. This momentum is expected to continue in the New Year,” said IATA Director General Willie Walsh.

And, while that's not a full recovery to 2019 levels, overall capacity has also not recovered. Total airline seats available actually sits "around 18% below the 2019 level," according to a report from industry analyst OAG.

So, basically, the drop in passengers equals the drop in capacity meaning that planes are flying full. That's one half of the equation that keeps airfare prices high and the second one looks bad for anyone planning to fly in the coming years.

Image source: Getty Images.

Airlines Face One Key Rising Cost

While airlines face some variable costs like fuel, they also must account for fixed costs when setting airfares. Personnel are a major piece of that and the pandemic has accelerated a pilot shortage. That has given the unions that represent pilots the upper hand when it comes to making deals with the airlines.

The first domino in that process fell when Delta Airlines (DAL) - Get Free Report pilots agreed to a contract in early March that gave them an immediate 18% increase with a total of a 34% raise over the four-year term of the deal.

"The Delta contract is now the industry standard, and we expect United to also offer their pilots a similar contract," investment analyst Helane Becker of Cowen wrote in a March 10 commentary, Travel Weekly reported.

US airfare prices have been climbing. They were 8.3% above pre-pandemic levels in February, according to Consumer Price Index, but they're actually below historical highs.

Southwest and United Airlines Pilots Are Next

Airlines have very little negotiating power when it comes to pilots. You can't fly a plane without pilots and the overall shortage of qualified people to fill those roles means that, within reason, United (UAL) - Get Free Report and Southwest Airlines  (LUV) - Get Free Report, both of which are negotiating new deals with their pilot unions, more or less have to equal (or improve on) the Delta deal.

The actual specifics don't matter much to consumers, but the takeaway is that the cost of hiring pilots is about to go up in a very meaningful way at both United and Southwest. That will create a situation where all major U.S. airlines have a higher cost basis going forward.

Lower fuel prices could offset that somewhat, but raises are not going to be unique to pilots. Southwest also has to make a deal with its flight attendants and, although they don't have the same leverage as the pilots, they have taken a hard line.   

The union, which represents Southwest’s 18,000 flight attendants, has been working without a contract for four years. It shared a statement on its Facebook page detailing its position Feb. 20.

"TWU Local 556 believes strongly in making this airline successful and is working to ensure this company we love isn’t run into the ground by leadership more concerned about shareholders than about workers and customers. Management’s methodology of choosing profits at the expense of the operation and its workforce has to change, because the flying public is also tired of the empty apologies that flight attendants have endured for years."

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