How Wall Street Views The Fed’s Interest Rate Decision
I often think of Wall Street as the smallest town in America. It has its own language, its own way of doing things, and, above all, its own way of viewing the world.
For those who have been watching the Street over the past day, you’ve seen that “small town” come together, building a consensus about our economy and how investors should react. This unified reaction will climax at 2 p.m. Eastern time Wednesday afternoon when the Federal Reserve announces its latest interest rate decision. And the odds are that Wall Street’s estimate will prove right “on the money.”
But to get a complete picture of what’s been occurring in our virtual financial “small town,” we must return to yesterday’s events. The Labor Department reported that total Employment Costs rose by 1.2% for the first quarter of 2024.
Now, you may say that’s not much, and of course, you’d be correct. This quarter’s increase in wages and benefits barely exceeds the cost of living. After all, for most of 2023, wages and benefits fell far behind the cost of living, so this is just a chance for American workers to catch up.
At least, that’s how the rest of America sees yesterday’s report on labor costs, which is just the first opportunity for paychecks to catch up to rising costs. But that’s not how the small town of Wall Street views it. Yesterday, the Street was looking beyond the cost of labor to today’s Federal Reserve decision on interest rates. From that point of view, any expense increase, even labor costs, translates into overall higher inflation. And higher inflation is just what the Fed is fighting with its elevated interest rates.
Yesterday’s good news for this country’s working men and women will translate into elevated interest rates for a longer period — something that the Street wants to avoid.
All of this is not new; it is part of a time-honored script that’s been going on in the American economy for at least the last half century that I’ve been around. All the people in this country who filed their latest IRS Form 1040 to report their wages or salaries and income fall into the working category, at least from the view of economists and analysts. Inevitably, these people, along with those with “fixed income (mainly retired), are the hardest hit by rising prices, i.e., inflation.
These are also among the last to receive relief. For many, relief only comes in the form of a pay raise. And raises often involve complex negotiations between an individual, a union, or associations and the “boss” or management — never an easy task. These negotiations over pay take time. And it’s for that reason that labor costs most often come at the very end of an inflation cycle.
So, we should view yesterday’s Employment Cost Report as good news. This current bout of inflation is most likely nearing the finish line, and labor costs are signaling that.
However, back in our little town of Wall Street, that’s different from how they greeted the news. From the Street’s perspective, all they could see were higher labor costs, and they immediately concluded that the Fed would stand pat with higher interest rates. That’s why the Dow was down over 500 points yesterday.
I have no argument with that position; the Street is likely correct. The Fed will inevitably hold interest rates steady and likely sound pretty hawkish toward ever-lowering rates. But that’s because that’s just how the Fed acts. They revert to the status quo ante every time. This group, under Chairman Jerome Powell, is particularly averse to “rocking the boat.”
On the other hand, I’m looking for some significant external event, perhaps a bank failure, the burgeoning commercial real estate collapse, or a transition from “cold” to “hot” in one of the many wars we are facing, to finally force the Federal Reserve to lift its foot off the monetary brakes.
For Wednesday’s announcement, the little town of Wall Street is likely correct, with no change in interest rate policy and hawkish projections from the Federal Reserve.
But, just between you and me, baring something completely unseen, it’s becoming increasingly probable that inflation is fading.
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