The Fed, UAW Strike and More

Ali Jaffery: The lags of monetary policy tightening might be a lot shorter, and if that’s the outlook that they have embedded. One view is that it implies we hold rates for longer, but it also might imply that the Fed is worried that activity might strengthen again. And so there’s the risk of holding higher for longer, but that activity could resurface.

Bipan Rai: Hello everyone, and welcome to another edition of the FX Factor podcast. I’m your host, Bipan Rai, and with me today, I’ve got a very special guest making his debut on the podcast, Ali Jaffery, who is a senior economist here at CIBC. Ali, welcome to the show. We got a lot to talk about.

Ali Jaffery: Thanks for having me. Pleasure to be here.

Bipan Rai: Excellent. I mean, look, we had several central banks reporting last week, obviously updating statements in their decisions. I guess the overarching theme is fairly consistent. I mean, most of them, you can make the possible exception of the ECB is now in the sort of data dependency mode where everything’s taken on a meeting by meeting basis. And the Fed is obviously at the forefront of everything. I mean, what’s your read on the Fed right now and where they’re at and where they could be in a couple of months from now?

Ali Jaffery: Yeah, I think it was a very interesting meeting with the Fed, and there are three key points to the last FOMC decision. The first is their choice to hold. I think that was an important signal that they’re pleased with the progress they’ve had on inflation so far. So I think that’s quite important. The second is obviously the set how the outlook changed and where the dots moved. So they’re quite concerned about the US outlook. They’ve significantly upgraded it and that requires more monetary policy tightening. Whether that transpires or not is dependent on that outlook. That was my read from Chairman Powell. But then the last point that I take from that is the press conference and the tone that Powell brought with him. And it was a lot less committal, I would say, to the policy path outlined in the set. And the key word of that press conference to me was caution. He said multiple times that we’re going to proceed with caution. So two dovish signals I take from that and one more hawkish signal, which is a set that hawkish signal is quite interesting because it’s a dramatic change in view for the Fed or the outlook. The listeners might know that the Fed revised its unemployment rate outlook from about 4.5% At the end of 2024 and 2025 to about 4.1%, which is just above the natural rate of unemployment that the Fed estimates and other people largely agree with. So they’re not expecting a substantial deterioration in the outlook. So that brings me to kind of the big risks that the Fed might have in their mind is that the lags of monetary policy tightening might be a lot shorter. And if that’s the outlook that they have embedded, one view is that it implies we hold rates for longer. But it also might imply that the Fed is worried that activity might strengthen again. And so there’s the risk of holding higher for longer, but that activity could resurface and that they might act again as well, implicitly in that that’s not our view, and I think that’s not the market’s view yet either. But there they’re clearly signals that that’s a big risk, and they’re worried about it.

Bipan Rai: So we talked a little bit immediately after the release about the fact that if you look if you take stock of everything and I think you highlighted this a little bit, you consider the statement, you look at what’s being projected with respect to the unemployment rate, inflation growth forecasts and the dots and the way they’re shifting. There’s a bit of an inconsistency there, right? I mean, what’s your read on that inconsistency? Why is it there and how would you interpret that for our audience?

Ali Jaffery: So first off, the FOMC is, you know, a dog’s breakfast of different views. So almost always there’s an inherent inconsistency, and Powell is really good about downplaying that. And that’s my main takeaway about that and Powell said that, you know, this is not a plan. But also I look at the dispersion of the dots, particularly on the Fed funds rate, as signaling that they’re unsure about the future. So I try not to look into it too much. And it also raises questions for me about how much this is actually going to play out and whether there’s some tactical element in this as well, whether they’re trying to ensure that financial conditions don’t ease too quickly, even though they might not be planning to hold as long or as high or to raise rates further. So I think there are some tactical considerations and uncertainty underlying that inconsistency.

Bipan Rai: So, I mean, if we look at the dots, if we take them at face value, the Fed seems to think that there’s one more left for this year. Our call is that there’s not. Can you explain why we differ from the Fed and what are the risks to that view?

Ali Jaffery: So I think the Fed has a 12 to 7 majority in favour of another hike this year, which is not an insignificant that’s a majority. Clearly it’s not overwhelming, but it’s not on the knife edge either. But Powell said in the press conference that they want to see more than three months of good data. And my sense is that we will likely see that on inflation in labour, which is why we maintain our view that the Fed won’t proceed. So he essentially left the door open to either possibilities. It probably would have signaled to dovish of a move to remove it, and I think that’s a fairly appropriate bar for them to say that they want more than just three months. And also underlying the inflation picture for the Fed is what’s causing inflation to come around target or actually slightly below. And the prevailing view is or at least why commentators and different decomposition of inflation that it reflects supply factors dissipating and not demand, demand is obviously quite strong. So the durability of that supply side easing and its impact on inflation is a big question mark for the Fed. They don’t want to plant a flag not knowing how much more there is to run on that. And so inflation could come back again. My sense is that there is more to run on the supply side that’ll help keep inflation around target, even though demand is quite strong. And that should keep it at a range where it’s prudent for them to hold rather than hike.

Bipan Rai: So we like us as market participants and we’re looking at we’re trying to sus out what the Fed is going to watch in order to get that sort of real time approximation of how, you know, we’re seeing the supply side evolve to the different and changing dynamics. What are the indicators that you think the Fed is eyeing? Is it really just developments in the labour market, maybe a decline in job vacancies? I know you take a different view with respect to vacancies as the most most of us here. What indicators should we be looking at if we want to really get a same feel as the Fed does?

Ali Jaffery: That’s a great question. So there are two broad sets of indicators we should be looking. One is the goods market, product market and then obviously in the labour market. So we’ll start with the goods market. The indicator that I look at the most is the New York Fed’s measure of supply chain disruption, and that has obviously eased substantially, is in negative territory, suggesting that the supply chain disruptions have mostly healed from a global perspective, and then more subsector indications like the Manheim used car index to see whether that used car prices are stretched or not. And then different decomposition of inflation in terms of demand and supply that look at the change in prices and quantities. That’s very helpful on the good side, and that’s very important because we saw most of the increase in the run up in inflation initially was because of the goods sector on the labour market. Looking at job vacancies is one of the measures and as you mentioned, I’m concerned that it doesn’t tell the full story because the structure of hiring has changed over the last decade and particularly the post pandemic. It’s much cheaper to post a job vacancy.

Bipan Rai: On LinkedIn, for example.

Ali Jaffery: Exactly right. So whether or not the level of vacancies is consistent with 2% inflation is always difficult to sus out, but nonetheless, it’s one indicator. The one I put the most weight on is the part rate. There are people coming back into the labour force, right? That’s the biggest measure of kind of supply in the economy. The amount of average hours worked. So from a classical macro point of view, the total hours worked, which is the product of the number of people working and the average hours that they’re working, gives us a sense of what’s the labour supply from a rough point of view. But underlying the number of people working is who is participating in the labour force, and that hasn’t fully recovered to its pre-pandemic. We wouldn’t expect it to go back though because of population ageing; that should trend down. But we’ve seen a very significant run up in the part rate over the last year. It’s slow but it’s still moving in that direction. In fact, we recently had a 0.2 percentage point print in the part which that’s not a fast moving indicator. So I put a lot of weight on the part rate first and then vacancies second.

Bipan Rai: And for our listeners, part rate, you mean participation rate of the labour force, correct?

Ali Jaffery: That’s right.

Bipan Rai: Okay. Excellent. So I mean, another key ingredient of this that I want to get your thoughts on and, you know, everyone seems to be talking about this with the UAW Workers strike in the United States is wages. How do you see the wage picture evolving from here? And can you comment a little bit on what’s going on with respect to the UAW strike and whether you see that as a permanent issue for the labour market in the United States and whether or not the Fed is going to react to a prolonged strike?

Ali Jaffery: That’s a great question. So starting with wages, so we’ve seen some really encouraging wage data in the US. The United States obviously has very rich wage data that adjusts for the change in industries. So the employment compensation index is what I place the most weight on, because Chairman Powell has said that repeatedly, and that has seen a significant easing in the last few quarters, which is very important. And we would expect wages to moderate going forward because we’ve seen excess demand in the labour market come down, but at a fairly gradual pace. So that’s the underlying view of wages. It should it should slowly come down. But there are risks to this view. You know, the first is that, you know, wages are relatively sticky and there’s a concept economists call downward nominal rigidity. So, you know, when the economy slows, there’s a reluctance. Obviously to cut wages and firms just fire people or adjust their hours. So wages adjust in a slow fashion. But also workers look at past inflation when they try to bid up their wages. And obviously past inflation has been quite high. So there are forces that will probably cause this adjustment in wage growth to be possibly slower, and that could be slower than the Fed likes. So those are some important risks to the wage outlook, even though the economy is moderating, moving in the right direction. Now, with respect to the UAW strike, this will be important to wages to some degree. Autoworkers are not the majority of the labour force, but what they get in this negotiation will likely be a benchmark for suppliers and people who are connected to the auto industry. Now for the economy as a whole, we think that it would be a modest impact if it’s a if the strike lasts about four weeks to five weeks, like some of the historical episodes in the past, that for each week of the strike, it could shave off about 0.1 percentage points of annualised GDP. That’s not a lot. But if that stretches out for quite a while, that could be important and that impact could be non-linear, as you say, meaning that as it goes on, that might not just be a 0.1, it could be a 0.2 or 0.3 because you can knock off effects suppliers and their suppliers and their workers. And so even though it’s the auto sector, auto production is only around 3% of GDP. It may be connected to sectors that account for a larger pool of GDP and employment. So the risks to that depend entirely on how long, how long it lasts. But right now, our base case view is that it doesn’t last too long. We’re almost nearing it at the two week period as we get to three weeks and as we get to four, then I think the risks become much higher.

Bipan Rai: Yeah. So let’s, I mean, let’s talk about the auto sector in the United States and in North America in general. We know it’s 3% of US output, as you mentioned. But there are also heavy linkages across the border to southern Ontario. I mean, when did when do we start seeing signs of pain in the Canadian auto sector? We see a prolonged sort of strike in the United States.

Ali Jaffery: I think it could be pretty quick. You know, it could be within a quarter, maybe two quarters. A prolonged strike, because as you mentioned, there’s significant interlinkages between these firms. There’s a lot of cross border trade. You know, there’s inputs that come across the border and go back and forth. So these disruptions could show up, I think, quite quickly. We don’t have the rich micro data to assess that impact and the speed. So that’s a bit of speculation on my part. But knowing how well integrated these are, you’re already seeing in the US suppliers that are not related to UAW shutting down. So I think that it might be wishful thinking to think Canada is isolated from this in a prolonged strike scenario.

Bipan Rai: Okay. So on balance, when it comes to the Federal Reserve, we’ve got them on hold until the end of this year for 2024. What do you expecting? I mean, we are looking for rate cuts, but what’s the narrative there? How what should we expect in December 2024 for the Fed funds rate?

Ali Jaffery: So we think that it’s going to come down by, I think, around 125 basis points from what we have now. However, the Fed is saying quite clearly that they don’t believe that, and again, it could be tactical considerations, but if they’re upside risks to growth, then there would certainly be upside risk to our outlook on rates as well. So that’s a call that we made earlier in September, and we’ve had some important data that’s shown that the economy is more resilient. We get also the personal income report this week that will give us a pretty good view on consumption in Q3. Now, there could be a temporary snag with all these things with the auto strikes, the government shutdown and student loan repayments. But my sense is that there are plausible upside risks to our call, you know, and we’ll revisit that as we get the data and assess the outlook and as also as the inflation outlook evolves, given that complicated supply and demand story that we talked about earlier.

Bipan Rai: So there you have it. Lots of takeaway here. Lots to unpack. Certainly when it comes to the UAW strike in the near term. We’ll have to keep tabs on how long that extends for, to what degree that could hamper things north of the border as well. And judging by what Ali has told us, there is some considerable upside risk to US data going forward. And that really does dovetail with our view that the US dollar could remain strong into year end and potentially carry that strength into the first quarter of next year. So that’s going to be some something that we’re going to be watching as well. I really would love to have you back again at some point in the future to talk not just the US but also Canada as well. So we’ll have you back for the next Bank of Canada meeting.

Ali Jaffery: Thanks. Pleasure to be here.

Bipan Rai: Excellent. Thank you all for joining us, till next time. Cheers.

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