There are many “Rules of Thumb” that I have learned a great deal from over my life. These are old sayings, born of real-world experience, that can help us to avoid classic mistakes if followed. They typically provide the wisdom that is acquired based on other’s mistakes. One rule of thumb that I heard many years ago is that when working with machinery, torque plus speed breaks things. In other words, the faster a piece of equipment moves and the more torque it carries with it, the probability of destroying things, including your valued piece of equipment, rises. I have always been careful to apply this rule of thumb in working with my 1943 Farmal H. My cousin from the farm often tested this rule of thumb when he was younger, living on the farm, much to the consternation of my Uncle. The repairs to both the tractor as well as either the disc, plow or other attachment that was being pulled.
I point to this rule of thumb as I consider the path before the Federal Reserve. It has become clear that inflation has gone beyond a transitory stage and can now be considered systemic. Discussions this past week involving both the media as well as voices from the Federal Reserve centered on the speed and amount of interest rate hikes that might be needed this year to get inflation under control. Boiling down the discussions, they remind me of the torque and speed rule of thumb. The formula here for speed is how often the rates will be increased. Torque is the magnitude of the rate increases both in individual increases as well as the total change in the rate in 12 months.
The Federal Reserve may have run past the optimal time to start making movements to address inflation. As inflation heated up with the growth in the economy, rate increases could have avoided some of the price jumps later in 2021. Had demand been dampened by higher rates, the Fed could have gotten ahead of the supply chain issues.
With the labor report this past week showing a larger than expected jump in new jobless claims, we could be seeing the start of a softening in the economy. The Empire State Manufacturing report dropped off a cliff, falling from 31.9 in December to a negative .7 in January. There was concern in this report as new orders and production back logs dropped off. These are clear signs that something at the core has changed. To be fair, the Philly Fed manufacturing report grew in January. Part of this was due to the big drop that Philly had last month. This was a slight rebound and was likely impacted by the weather. The employment portion of this report did drop in January indicating that businesses are in need of fewer workers.
Prices continued to show strong increases in both Fed Reports, mostly targeted at supply shortages across the board, not just in singular products.
A harbinger if things to come was the drop in existing home sales by 4.6% in December. As mortgage rates rise, borrowers get priced out of the qualification side of the purchase equation. Typically, when rates rise, home prices will fall. This is not occurring, making affordability gap created on two fronts.
Based on the increased unemployment numbers, softening of consumer sales numbers, flattening oil production and continued supply issues, it appears that inflation is dampening the economy and will continue to do so for some time. While most of the world has returned to pre pandemic employment levels, the US still lags where we were two years ago. As the economy softens, the labor market will cool this Spring. This will point to the end of the wage hikes, leaving most workers in a much poorer condition than they were prior to the pandemic.
Now, tack on interest rate hikes both in number and value, speed and torque, and you can see how the Fed could break our economy in 2022.
Now on that cheery note, Have a great week.
