S&P500 and tech-heavy Nasdaq plunged the most in a single month since the pandemic-induced crash in March of 2020, stopping just shy of 9% and 14% drops. This is, in part, because the economy is doing too well.
“April is the cruellest month,” starts the poem Waste Land by T.S. Eliot. Indeed it was, for US equity investors. S&P500 and tech-heavy Nasdaq plunged the most in a single month since the pandemic-induced crash in March of 2020, stopping just shy of 9% and 14% drops. This is, in part, because the economy is doing too well.
So good it’s (going to be) bad
Yes, the economy is growing too fast. How can that be? The advance report for Q1 GDP showed contraction!
In short: economic reports can rarely be taken at face value due to a range of special factors and adjustments that go on behind the scenes. Take them seriously, but not literally. This one had a range of special factors that markets mentally stripped out almost immediately: a surge in long-delayed imports, for example, that had been sidelined due to logistical issues.
The consumer cavalry to the rescue
The one component that mattered in that report was domestic consumption. “Real private domestic final sales” - a term that rolls easily off your tongue and is the best proxy for domestic consumption - actually grew at a stronger, 3.7% pace in the first quarter than the 2.6% in the previous period.
The US consumer, propped up by government fiscal largesse and the strongest labour market in decades, is feeling confident and is spending prodigiously.
A bigger concern for the Fed will be the sharp 1.4% jump in the employment cost index for the first quarter, which brought the year-over-year increase for civilian compensation to 4.5%.
Economists are fine with inflation until it starts showing up in wages: then the panic sets in because - unlike goods and services - wages generally only adjust up, never down, and in a service-driven economy propagate through much of it very rapidly.
The stronger the economy, the faster it happens as job candidates demand ever higher wages to hop from one job to another.
In fact, Chairman Powell remarked last December that the pickup in the ECI for the third quarter had helped persuade him to step up the Fed’s balance-sheet tapering.
Step on it
The Fed meets mid-week to deliver a now widely-anticipated half-point hike.
The aptly named “Misery index” - a gauge of how well the Fed is doing its job - shows the tricky time it’s been for policymakers of late. COVID first pushed the misery index up because the unemployment rate spiked (Fed is by law tasked with keeping the nation at full employment). When that came down, inflation exploded higher.
In his quest to avoid the fate of former Chairman Arthur Burns (a name synonymous with overly lax inflation policy), Powell and Co. may well decide that accelerated tightening - and a hard economic landing - is the only way to slay the inflationary dragon.
Engineering policy to deliver the “just right” low inflation and low unemployment rate will require more than a little luck.
Barring that, a recession next year seems more or less inevitable.
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