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Wage Inflation That Will Determine What the Market Does Next

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https://realmoney.thestreet.com/investing/stocks/forget-cpi-it-is-wage-inflation-that-will-determine-what-the-market-does-next-16111227
 
Forget CPI, It Is Wage Inflation That Will Determine What the Market Does Next
 
Consumer prices are easing, but wages are still strong and will be the key issue addressed by Fed Chairman Jerome Powell after today's rate hike announcement.
 
By JAMES "REV SHARK" DEPORRE
 
December 14, 2022 | 07:50 AM EST
 
On Tuesday, lower-than-expected Consumer Price Index data produced a mixed celebration on Wall Street. The market gapped sharply higher on the lower numbers but then sold off steadily for most of the day. The indexes finished the day in the green and breadth was positive, but it was not the euphoric response that many bulls were expecting.
 
The problem was that the market already had discounted peak inflation to a great degree. CPI has been in decline for a few months already and market players anticipate that it will continue to trend down in the months ahead.
 
Inflation was one of the primary causes of the bear market, but it is a more difficult problem than just CPI. Here on Wednesday, we will hear from the Fed and are likely to listen to comments from Fed Chairman Jerome Powell about how the battle against inflation is far from over.
 
In a speech at the Brookings Institution on Nov. 30, Powell explained that there are three components to core Personal Consumption Expenditures (PCE) inflation, which is the Fed's primary concern. The three components are goods inflation, housing inflation, and inflation in core services other than housing, which is mostly labor.
 
Goods inflation is reflected in CPI, and that is what the market celebrated on Tuesday. Housing is already seeing a sharp decline due to higher interest rates. However, the labor market remains a big problem. Labor is the biggest component and is almost half of PCE inflation. It reflects things such as health care, education, restaurants, haircuts and all sorts of services.
 
The problem the Fed faces is that the demand for labor far exceeds the supply, which is driving wage inflation. According to Powell, "Job openings exceed available workers by about 4 million; that is about 1.7 job openings for every person looking for work. So far, we have seen only tentative signs of moderation of labor demand... job gains have stepped down from more than 450,000 per month over the first seven months of the year to about 290,000 per month over the past three months. But this job growth remains far in excess of the pace needed to accommodate population growth over time -- about 100,000 per month by many estimates. Job openings have fallen by about 1.5 million this year but remain higher than at any time before the pandemic."
 
This is a very difficult inflation issue that the market still faces. The only way the Fed can deal with wage inflation is by slowing economic growth and killing demand for more employees.
 
The improvement in CPI is good news, but the labor issue is why the Fed is likely to stay hawkish and will not declare victory over inflation any time soon.
 
Ironically, the extremely strong labor market is the main reason many folks are optimistic that we can avoid a recession, but the consensus is building that the recession is coming in large part due to the Fed's battle against rising wages.
 
The focus at the Fed meeting today is going to be Powell's tone. When Powell discussed this labor issue two weeks ago, the market ignored his warnings and was primarily focused on the likelihood that the Fed will raise rates by one-half percentage point today. That is still the case, but the market response will depend on the tone of the Powell news conference that follows the rate hike announcement.
 
The good news is that once the market digests this news, there will be little macro news impacting the market into the end of the year. I believe buyers are going to be looking to add exposure in hopes of quick gains before the start of 2023.
 
My game plan is to stay patient and see how the market reacts to Powell and then look harder to add long exposure.