5/3/2019 Weekly Update: Is the Phillips Curve Dead?
by David Rasmussen on Jun 7, 2019
S&P 500 +0.23%
10 Year Treasury -0.20%
Weekly Update: Is the Phillips Curve Dead?
Happy Friday! This week contained two market catalyst. The first was the Federal Open Market Committee meeting that concluded on Wednesday. As expected, the “Fed” left rates unchanged as they had previously signaled. Markets were particularly interested in how Jerome Powell would handle questions about stubbornly low inflation during the press conference post meeting. Mr. Powell used the word “transitory” several times to explain away the reasons for low inflation. He basically indicated that the Fed is likely to stand pat rather than bend to the market and lower rates. Before the meeting the market had priced in a rate decrease later this year. The market interpreted his comments as hawkish and the S&P 500 sold off roughly 1% while the VIX index, a benchmark for market volatility, jumped 30% intraday. This was the first bought of equity market volatility that we have experienced for several weeks and it was short lived.
The second catalyst was the jobs report this morning. The report was great news and bolstered the equity markets into the black for the week while volatility levels quickly subsided. The US Economy added 263,000 jobs in the month of April. Summary statistics follow:
What really goosed the equity markets today was, perhaps, the “goldilocks” nature of the report: strong job growth without upward wage pressure. Corporations have somehow managed to keep their costs of labor low despite the dwindling pool of unemployed potential workers. In previous economic cycles the laws of supply and demand have usually dictated that a lower supply of workers led to a higher cost of labor. This relationship is known as the Phillips Curve by wonky economists. The following chart depicts this relationship graphically during the last decade that the unemployment rate reached 3.6%, the 1960’s:
Source: Bureau of Labor Statistics
As you can see there was a clear reaction function: lower unemployment equaled higher inflation. This reaction function has broken down in modern times. The unemployment rate (graph below) has steadily declined while inflation has hovered at or below 2% since the financial crises.
The FOMC has a dual mandate: maximize employment while keeping inflation low. Historically this has been a paradox. Achieving one goal is usually at the detriment of the other. A yin vs yang. This was economics 101. A question to pose during your weekend social gatherings: Is the Phillips Curve Dead?
Have a good weekend.
Thanks for reading,
Zach and Dave
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