Good Wednesday AM,

Bonds sold off yesterday afternoon on what, I do not know.

I know that markets are volatile heading into any big news and are typically pessimistic for fear of losing. I would expect that caused yesterday’s selling. Today, the 10-yr is back to where it was prior to the selling but mortgage bonds have not recovered. Continuing on with today, it is Fed Day (yesterday was Golden Knights Day) we (I) have been waiting for. With yesterday’s tame CPI reading and todays weak PPI (Month over month at -0.3 vs -0.1 expected; Core Month over Month at 0.2 vs 0.2 expected), as well as the increase in jobless claims, the Fed should pause and have some encouraging things to say. Both inflation and employment are moderating. We should be done hiking. We will start to have more insight around 11 a.m.

Since it is all about the Fed today, I am including a few recaps from the WSJ and Bloomberg as a primer. I’m looking forward to writing tomorrow’s update.

The U.S. consumer-price index rose 4% last month from a year earlier, the Labor Department said Tuesday, well below a peak of 9.1% last June and down from April’s 4.9% increase. The figures show that the Federal Reserve has made progress in cooling price pressures but could have more work to do.

So-called core consumer prices, which exclude volatile food and energy categories, climbed 5.3% in May from a year earlier, down from 5.5% in April. Economists see core prices as a better predictor of future inflation.

On sort of the flip side; overall consumer prices increased a seasonally adjusted 0.1% in May from the prior month, down from April’s 0.4%. Core consumer prices rose 0.4% in May from the prior month, the same pace as in April and March, suggesting underlying price pressures remain firm.

The widespread expectation is that the FOMC makers will hold rates steady today. And that perhaps we might even get a proper pause in the hiking cycle. Zoom out, big picture, and it looks like inflation continues to decelerate. Here’s a YOY chart measuring CPI in a bunch of different ways.

On the other hand, core inflation has remained hot on a sequential basis.

Here is a good thread from Jason Furman breaking down what’s going on there, and why at least some softening should be expected. Whether that softening is enough is TBD. But anyway, the big picture is that the soft landing crowd lives to see another batch of data. Inflation is decelerating. The labor market remains robust. The unemployment rate is below 4%. The pace of job creation has been strong. Other measures of labor market utilization, such as the Prime Age Labor Force Participation Rate or the Employment-to-Population ratio have been impressive.

A plausible story you could tell about the last few years is that reversing destruction is hard and costly. Covid and the policies designed to mitigate its spread ground the economy to a halt virtually overnight in March 2020. It’s as if a building collapsed or was demolished almost instantaneously. There’s no way you can rebuild it as fast as it fell apart. However, if it’s an emergency and you must expedite its construction, it’s going to be particularly costly and taxing overall (you’ll have to pay more for round-the-clock labor, more for materials etc.).

In 2020, policymakers, having learned the lessons of the 2010s, decided not to let the Covid recession turn into a long, drawn-out downturn, with an aim to restoring maximum employment as soon as possible. And the labor market recovered far faster than anyone expected, and far faster than in any other previous downturn. Arguably though, the rebuilding process was costly and taxing to the system. Rehiring people is difficult when done in short order. We’ve never had months before, like we had in the middle of 2020, where millions of people were returning to employed status. Even the raw monthly job gains we saw in 2022 were extremely high by historical measures.

So perhaps in the short-run, the growth of the economy was quite literally unsustainable, as we got back to more normal levels of activity in record breaking time. This unsustainability showed up in higher prices, bottlenecks, supply chain breakages, shortages and so forth. In the long-run, our current levels of activity and labor market utilization may be consistent with more stable prices as growth becomes more normal.

At least that’s the hope anyway. We still have to see more data to find out if the story is true or not.

Please remain safe and stay healthy, make today great!