US equity markets Thursday continued their retreat following Fed Chair Jerome Powell’s now-celebrated “transitory” remark at yesterday’s Federal Reserve press conference.
Unexpectedly low inflation numbers, he said, were “transitory” rather than “permanent.” Interest rates rose and stocks fell, as investors reckoned that they had overshot the Fed’s willingness to cut interest rates.
The US last week reported March core inflation for personal consumption expenditures at just 1.6% year-on-year, down from 2% year-on-year at the end of 2018, lower than the consensus forecast.
This isn’t anything to get excited about. After a 65-basis-point slide since last October, inflation-indexed Treasury yields were due for a bounce.
Nothing really has changed, to be sure. Inflation remains much lower than the consensus expected. To the extent that the economic data tell us anything, it’s that the Phillips Curve – the supposed relationship between falling unemployment rates and rising employment – is dead.
That is not the advice that the Fed staff is giving Powell. The academic economists at the Fed continue to believe what Columbia professor and former Fed Governor Frederic Mishkin told CNBC yesterday: “The Phillips Curve isn’t dead! It’s hibernating!” They faithfully await the return of inflation, the way Linus waited for the Great Pumpkin.
The Bureau of Labor Statistics meanwhile reported that unit labor costs had fallen during the 1st quarter of 2019. The 5-year trend is gently downward, despite the lowest unemployment rate in roughly half a century. The BLS data are not that accurate, to be sure, but they do point down rather than up.
Survey data don’t show much of an inflationary impulse. The National Association of Purchasing Managers’ report for April showed a reading of 50 for prices paid by manufacturers, that is, no inflationary impulse.
The measurement of inflation is questionable. But the US corporate sector continues to find ways to outsource or automate functions ranging from customer help lines to project management. I don’t expect inflation to pick up during the next 12 months even if the unemployment rate continues to fall. The Phillips Curve may not be dead, but it is in a permanent coma.
The best way to address the issue in a portfolio context is to own US banks, whose stock prices tend to improve with higher interest rates. US bank stocks rose by about 1.2% on Thursday in response to higher yields. As I wrote on April 22, US bank stocks are reasonably priced at 11x forward earnings. The regulators have de-risked them, and they have finally understood their business model.
In effect, they are like utilities with mediocre return on equity, but a good deal of room to reduce costs by automating functions. As noted, they offer a hedge against rising yields.