The inflation signal keeping the Fed on edge

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Jan 28, 2022 View in browser   By Kate Davidson Editor's Note: Morning Money is a free version of POLITICO Pro Financial Services morning newsletter, which is delivered to our subscribers each morning at 5:15 a.m. The POLITICO Pro platform combines the news you need with tools you can use to take action on the day's biggest stories. Act on the news with POLITICO Pro. The Fed's preferred inflation gauge, the personal consumption expenditures index, is due out this morning and it's expected to be another doozy. But don't sleep on the lesser-known employment cost index, which also comes out this morning and will have increasing importance for the path of Fed policy in 2022 If you read Morning Money religiously, or you're just a Fed nerd, you know that Chair Jay Powell has flagged this somewhat obscure data point as something officials are keeping an eye on as they assess improvements in the labor market. The index, a quarterly report that details total employee compensation and the cost of labor for employers, jumped in the third quarter, and was one factor that prompted central bank officials to pivot toward tighter policy late last year, Powell said. Why does it matter now?  So far, Powell has emphasized that inflation has been driven largely by factors relating to the pandemic — stronger demand for goods has collided with supply constraints, pushing up prices. The longer that prices stay elevated, the greater the risk that higher inflation will become embedded in people's expectations. One place that could start showing up is in higher wages. " If that took hold, it would actually be more problematic than the supply chain disruption," said Kathy Bostjancic, chief U.S. financial economist for Oxford Economics. "It would signal perhaps something more permanent, and it would be that wage-price spiral dynamic that Powell and others have talked about." We're not at that stage yet, Bostjancic said, but we're starting to see wage gains broaden beyond workers near the bottom of the income scale. Powell said as much at his December press conference: "Wages have also risen briskly, but, thus far, wage growth has not been a major contributor to the elevated levels of inflation. We are attentive to the risks that persistent real wage growth in excess of productivity [growth] could put upward pressure on inflation," he said then. This week, he repeated nearly the same passage in his opening statement. But he omitted the words, "but, thus far, wage growth has not been a major contributor to the elevated levels of inflation." Why could this become a bigger problem now? Many employers go through salary renegotiations at the start of the year and could feel pressure to lift wages amid persistent inflation. Some businesses that may have raised wages last year but resisted raising prices, in hopes inflation would soon ease, could start to pass that on to consumers. "If real wages rise faster than real productivity, then unit labor costs rise, and then that sets off that dynamic where companies are paying more for workers, and it's starting to eat into their profit margins," Bostjancic said. "One way to offset that is to pass along higher prices to consumers. And that's where you get that virtual reinforcing spiral on the upside." Where are unit labor costs now? Bostjancic looked at the past eight quarters, or two years, to try to smooth out some of the volatility in the data. During that time, they've risen at a 4.9 percent annualized rate, the fastest since the first quarter of 1983. Aren't wage gains a good thing? Yes, but not if they're being eaten up by inflation. That might help explain why consumer sentiment readings — and the president's approval ratings on the economy — are so low, even while workers' paychecks are growing and economic growth is surging. If wages can continue rising while inflation declines, that might turn attitudes around, said Tim Duy, chief U.S. economist at SGH Macro Advisors. "The administration's problem I think is, to the extent that happens, it's not going to be felt in the first half of the year," Duy said. "If it's felt in the second half, does this really work its way into consumer expectations before the mid-terms?" IT'S FRIDAY — Four weeks down, 48 more to go. And just seven until the (official) start of spring. I'm looking at you, New Yorkers and New Englanders. Hope you've got the salt ready and the snowblower gassed up for this weekend's bomb cyclone. Send us your best snow pics, plus tips, ideas, feedback, at kdavidson@politico.com, aweaver@politico.com, or on Twitter @katedavidson or @aubreeeweaver.   DON'T MISS CONGRESS MINUTES: Need to follow the action on Capitol Hill blow-by-blow? Check out Minutes, POLITICO's new platform that delivers the latest exclusives, twists and much more in real time. Get it on your desktop or download the POLITICO mobile app for iOS or Android. CHECK OUT CONGRESS MINUTES HERE.     Driving the Day Fourth-quarter employment cost index, and December consumer spending and PCE inflation data released at 8:30 a.m. … University of Michigan releases consumer sentiment data at 10 a.m. CRYPTO SUPER PAC PLANS TO SPEND $20M — Our Sam Sutton: "A group of crypto financiers said Friday it's launching a super PAC that aims to spend more than $20 million to support congressional candidates ahead of the November elections. The backers include a top executive at the digital currency trading platform FTX, as well as SkyBridge Capital, the hedge fund led by former Trump communications director Anthony Scaramucci, who is trying to start a Bitcoin investment fund. "The group, dubbed GMI PAC, said it has already attracted $5.3 million in contributions that it will use to back candidates and members of Congress 'who work to give consumers and innovators the opportunity to build and use next-generation technologies and services here in America.'" BEHNAM SIGNALS CFTC WON'T RUSH TO REWRITE RULES FOR CRYPTO — Sam again: "CFTC Chair Rostin Behnam said Thursday his agency should tread carefully before drafting new rules or policy changes aimed at digital assets. 'I'd hate to be viewed as a fourth branch of government,' Behnam said during a virtual event hosted by the American Bar Association, adding that it would be a 'balancing act.' 'This requires conversations with Congress,' he said. 'This requires, obviously, conversations with stakeholders.'" — Meanwhile: Reps. Patrick McHenry (R-N.C.), Tim Ryan (D-Ohio) and nine other lawmakers on Thursday urged Treasury Secretary Janet Yellen to set a narrow lens when determining what digital asset businesses will be subject to new IRS reporting rules from last year's bipartisan infrastructure law. — And: Sen. Elizabeth Warren (D-Mass.) is drawing more Democrats into her crackdown on Bitcoin mining companies , which critics say contribute to climate change because of their growing electricity usage. Warren and seven other congressional Democrats on Thursday sent letters to several of the largest domestic cryptocurrency miners demanding more information about their power consumption and environmental impact. — Crypto in NY: Environmental advocates and key state lawmakers are pushing again this year for a three-year moratorium on permits for power plants that burn fossil fuels to mine Bitcoin, a measure that would be the first of its kind in the nation. SEC REVISITS EXECUTIVE PAY RULE — From Sam: "The SEC is reopening the comment period on an unfinished executive pay rule that was mandated under the Dodd-Frank law more than a decade ago. SEC Chair Gary Gensler on Thursday announced new tweaks to the proposal, which would require SEC-registered companies to disclose how executive compensation reflects their underlying financial performance." IRS BACKLOG DELAYED EMERGENCY RELIEF FOR BUSINESSES — Our Aaron Lorenzo: "Emergency tax refunds meant to help businesses weather pandemic woes were significantly delayed because their applications got ensnared in the IRS paperwork backlog, according to a new Government Accountability Office report. The holdup required the IRS to shell out tens of millions of dollars in interest on top of the refunds." — GAO also said the Treasury Department lacks the ability to identify and recover fraudulent payments under its $46.5 billion rental aid program, our Katy O'Donnell reported. U.S. ECONOMY GROWS AS FOURTH-QUARTER GDP SHOWS STRONGEST YEAR IN DECADES — WSJ's Josh Mitchell: "The U.S. economy grew rapidly in the fourth quarter of last year, advancing to a 6.9% annual rate, capping the strongest year of growth in nearly four decades as the country rebounded quickly from the pandemic-induced recession. But growth recently has run into obstacles that could lead to more modest growth this year, economists say." — Biden statement : "The GDP numbers for my first year show that we are finally building an American economy for the 21st Century, with the fastest economic growth in nearly four decades, along with the greatest year of job growth in American history. And, for the first time in 20 years, our economy grew faster than China's." U.S. CHAMBER ISSUES RARE WARNING ON RASKIN — Reuters' Andrea Shalal: "The U.S. Chamber of Commerce on Thursday sent an unprecedented letter to lawmakers raising concerns about Sarah Bloom Raskin, President Joe Biden's nominee as the Federal Reserve's vice chair for supervision, and her calls for federal regulators to transition financing away from the fossil fuel industry. "The U.S. industry lobby group urged leaders of the Senate Banking Committee to question Raskin about those statements and her criticism of the Fed for allowing oil and gas companies to access emergency pandemic funds, among other issues." CTC RECIPIENTS WONDERING: WTF HAPPENED? — Our Adam Cancryn: "Lawmakers are currently scrambling to try to find a way to extend the expanded child tax credit, with the Biden administration stressing that it remains a priority. But there is no indication that an agreement is coming soon, if at all. And, in the interim, those who leaned on the policy to navigate the pandemic and lift their children out of poverty are struggling to adjust both their perceptions of political leaders and the day-to-day chaos of their own lives." Jobs Report Kristen Hutchens has been promoted to director of policy and government affairs at the North American Securities Administrators Association. Prior to joining the group in May, she worked at the Municipal Securities Rulemaking Board and was a staffer on the Senate Banking Committee.   STEP INSIDE THE WEST WING: What's really happening in West Wing offices? Find out who's up, who's down, and who really has the president's ear in our West Wing Playbook newsletter, the insider's guide to the Biden White House and Cabinet. For buzzy nuggets and details that you won't find anywhere else, subscribe today.     Fly Around The end of the Fed's easy-money era is prompting investors to reverse course on two years of investing strategies, kicking off this month's broad market rout, the worst selloff since the early days of the pandemic. — WSJ's Gregory Zuckerman, Gunjan Banerji and Michael Wursthorn The UK and EU are preparing to hit new Russian gas projects with sanctions if the Kremlin orders an attack on Ukraine, the first time Europe has weighed targeting a sector it relies on for 40 percent of its gas imports. — FT's Henry Foy, Sam Fleming, David Sheppard and Laura Hughes Apple Inc. rallied in late trading after quarterly revenue sailed past Wall Street estimates, marking a victory against a supply-chain crunch fueled by the pandemic and chip shortages. — Bloomberg's Mark Gurman The U.N. chief urged nations Wednesday to greatly boost humanitarian aid for millions of Afghans living in "a frozen hell" and release nearly $9 billion in frozen assets to pull Afghanistan's economy back from the brink of a collapse that could set off a mass exodus of people fleeing the country. — AP's Edith Lederer   Follow us on Twitter Mark McQuillian @mcqdc Kate Davidson @KateDAvidson Aubree Eliza Weaver @aubreeeweaver Ben White @morningmoneyben Victoria Guida @vtg2 Katy O'Donnell @katyodonnell_ Zachary Warmbrodt @Zachary   Follow us

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