As the economy booms over the next couple of months, the Fed will have a more difficult time defending its super-easy policies.
Economists expect the second quarter to grow by more than 9%, and the monthly jobs reports are likely to show very strong hiring, with job growth averaging more than1 million new payrolls in each of the next several months.
Already the reaction to March’s surprisingly strong jobs report could be a sign of more to come. March’s report Friday showed the surge in new jobs to 916,000, nearly 250,000 more than expected.
After the data was released Friday, the fed funds futures market began to immediately bring forward expectations for a Fed rate hike to December 2022, from the spring of 2023.
“Friday took us to the other side,” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. “That’s a full year ahead of where the [Fed forecasts] are telling us the majority of the committee is. They’re still looking at 2024 as their first hike.”
Jim Caron, head of global macro strategy at Morgan Stanley Investment Management, said the Fed is facing one of its toughest tests ever.
Last year, the Fed moved to a new inflation policy, where it would tolerate a range for inflation, on both sides of its target of 2%. The Fed will have to defend its zero interest rate policy and its bond purchasing program as a whole wave of data shows a big jump in economic activity and inflation, which could rise well above 2%, at least temporarily.
Because of the economic shutdowns a year ago, inflation this spring could look hot when compared to the low base of a year ago. Fed Chairman Jerome Powell has said the Fed expects a transient increase in inflation, but some in the market expect a higher level of inflation based on surging demand and and also government stimulus.
“They’re going to go through the gauntlet now. They’re going to go though the toughest part of the gauntlet in April and May,” Caron said. “The data is going to be good. This quarter is going to test their credibility …The second quarter is going to be plus 10% growth and inflation is going to get to core PCE around 2.5%, and they’re going to say, ‘this is transitory.’”
More inflation signs ahead
As the data gets better, the Fed’s job will become even harder. The consumer price index is released next week, and it could start to show signs of inflation just because of the comparisons with last March’s decrease in many prices. CPI for February was up 1.7%, the biggest gain in a year.
“They want a full recovery and they will wait it out. That said, the concern is not just what we’re getting in stimulus but whether you get additional stimulus in infrastructure,” said Grant Thornton chief economist Diane Swonk. “The Fed is not going to put that in their forecast until they see it, but the bond market is front-running that.”
Swonk said the inflation data could be very strong with CPI over 3%, and some components within the data spiking. “Used vehicles are going to be up 35% versus year ago because they plummeted a year ago. There’s a potential for some really weird numbers in there,” she said.
Treasury yields have rising on economic optimism, expectations for inflation, and stimulus spending that should increase Treasury supply and boost the economy. Congress recently approved a $1.9 trillion stimulus package, and some of the money has made its way into the economy. President Joe Biden last week unveiled a $2 trillion infrastructure plan.
The benchmark 10-year Treasury, which influences mortgages and other loans, was at 1.71% Monday. It gained about 90 basis points in the first quarter.
