The Fed Got Busy. America’s central bank put its money where its mouth is last week, raising interest rates by 50 bps – the first such hike since 2000 – and announcing plans to accelerate the shrinking of its massive balance sheet as soon as next month. Fed Chair Powell took the unusual step of suggesting that the Fed will hike rates an additional 50 basis points at both the June and July meetings, but dashed prospects for a 75-bps hike as some had forecasted. The Fed’s voting committee’s meeting statement highlighted strong consumer spending and business investment, which suggests the Fed won’t be swayed off its hiking path by the recent negative GDP print for Q1.

Regarding balance sheet reduction, the Fed detailed its plan to begin reducing its balance sheet on June 1^st by an initial $47.5 billion per month ($30 billion Treasuries and $17.5 billion in mortgage-backed securities) for three months with a $95-billion-per-month cap ($60 billion Treasuries and $35 billion mortgage-backed securities) taking effect in September. Such moves would roughly translate into about 25 basis points of tightening over the next year.

All told, Chair Powell was unexpectedly optimistic regarding the prospects for an economic soft landing, and less insistent than some expected regarding the necessity of raising the Fed Funds rate above neutral, a level he put at between two and three percent (Fed Funds is one percent now). By week’s end, markets weren’t buying Fed Chair Powell’s’ smooth talking, as evidenced by a sustained fall in the equity markets and notable increases in longer-term Treasury yields.

Our take:  We’re now expecting the Fed to stay true to its word and hike rates by 50 basis points at its June 15^th and July 27^th meetings, but then pause to reassess, with the Fed Funds rate topping two percent by the end of the year. Such moves would help the Fed avoid crashing the economy as it fights inflation.

Solid jobs data fed both sides of the recession debate. Headline nonfarm payrolls rose 428K in April (vs 428K in March) above consensus estimates and the twelfth straight month of job gains. Negative revisions – an unusual occurrence during the pandemic – showed that hiring was weaker in the previous two months to the tune of 39K. The unemployment rate held steady at 3.6% and wages rose 0.3% in April after rising 0.5% in March.  Wage growth now appears to have peaked, though the pace is still much faster than what the Fed wants to see to keep inflation in check.

The household jobs survey, on the other hand, painted a very different picture than the headline data, showing a 353k decrease in employment, owing primarily to a reduction in the labor force (-363k) and a minor decline in the number of jobless (-11K).

Our Take: The household jobs survey paints a gloomy picture of the jobs market, while the headline survey says hiring is still going strong. Which is correct?

Due to data distortions caused by the pandemic, the two surveys, which are conducted independently, have varied significantly over the last six months. We expect a general narrative to emerge as the volatility in the data smooths out over the coming few months: more workers returning to work and wage growth slowing.

We suspect that America’s job creation engine will sputter in the coming months to approximately 200-250K in new jobs per month on the back of slowing demand for workers in some of the economy’s most interest-rate sensitive sectors: housing and construction. Consumer’s continued shift from goods to services will add to the job creation slowdown, as demand for jobs in transportation and warehousing also declines. It’s a dynamic that will give the Fed breathing room to tighten less than markets currently expect.

Lockdowns hit China’s economy and ensure that inflation remains stubbornly high here at home. In April, China’s economy slowed dramatically as it battled the spread of COVID-19. Last month, output in both the manufacturing and service sectors fell due to lockdowns in certain regions and more far-reaching mobility restrictions in others. In-person service restrictions helped push the services sector purchasing managers index down to 41.9 from 48.4 in March, while the manufacturing index fell to 47.4 from 48.4.

Despite rising social unrest, China’s President Xi Jinping reaffirmed the government’s commitment to its zero-COVID policy, warning against any easing in mitigation measures. The dynamic all but guarantees that supply chain snarls will be with us for longer, and that prices for a variety of goods will remain stubbornly high, emboldening the Fed to stay well on its hiking path into the summer at the very least.