Fed preaches patience in the face of inflation, jobs show guts and interest rates fall
The Fed meeting and the October jobs report were the dominant market events in the first week of November. Both drove the stock markets higher. On Wednesday, the Fed appears to have taken a more accommodative stance on future interest rates than indicated by their September dot plots, which markets are using to judge the onset of rate hikes. (The “dots” are individual FOMC members’ forecasts for future interest rates.) The jobs report (seasonally adjusted + 531K) on Friday surprised Wall Street (+ 450K consensus), but it failed us. not surprised. At the end of the week, the markets seem convinced that the rate hikes are still a long way off.
While the jobs report looked solid, several nuances are worth discussing:
- The September jobs total was revised up from + 119K to 312K from 193K, and August’s total from + 116K.
- The employment-to-population ratio and the labor force participation rate (that is, the percentage of the population (labor force) that is employed or seeking) are expected to increase in October, as Federal Unemployment Supplements ended on Labor Day weekend. But they didn’t. As a result, the U3 unemployment rate fell to 4.6% from 4.8% and the U6 rate, a larger measure, to 8.3% from 8.5%. This is a worrying issue, as those in additional unemployment positions were expected to be looking for work by mid-October, when the surveys were conducted. While they may not return to their pre-pandemic levels (pensions, etc.), we still believe these ratios will increase in the future. This makes the Fed’s job more difficult, as rising participation rates raise the unemployment rate, all other things being equal.
- On the negative side, the work week contracted slightly, which affected average weekly earnings. They were flat and were the sweetest in eight months. This has a direct and immediate impact on consumption.
- According to the sister household survey, around 40% of job growth was part-time, which explains the contraction in the work week.
- For those who closely follow the employment figures, remember that the BLS “adds” a residual number to the survey data, called the “birth-death” model (creation of new unaccounted for minus defaults). It was around 130K, so the “counted” number was closer to 400K.
- Hourly wages increased by + 0.36% (4.4% year-on-year). For those worried about inflation, this is the lowest impression in eight months. Before the pandemic, that number was consistently around 3.5%, but often deviated from 4.5%. In this context, that does not give us inflation worries.
Looking at weekly employment data, Initial Unemployment Claims (IC) and Continuing Claims (CC) continue to march towards their pre-pandemic norms. CIs, at + 240K for the last week (October 30), are rapidly approaching their pre-pandemic norm of + 200K (see graph).
The story is similar for CCs, now at 2.7 million compared to 2.1 million before the pandemic. Note the sharp drop in CCs since the end of federal unemployment supplements (September 4).
State CCs from this same week (September 4) to the last week (October 23) show considerable progress. Using the week of May 15 as a base, the table shows the percentage drop in unemployment for opt-in states (those that paid the federal supplement) and opt-outs from May 15 to September 4 (the end of programs federal) then from May 15 to the latest data (October 23).
As measured from the May 15 baseline, opt-in states (those paying the federal supplement) lagged behind opt-out states in reducing unemployment while the supplements were in place. Withdrawals improved their unemployment by 44.5%. points, while Opt-Ins improved by 27.9 points. Since the supplements ended, the gap appears to have closed with withdrawals improving by 16.0 pct. points and opt-ins by 12.8. From these data, it is hard not to conclude that federal programs have had a negative impact on labor markets and are at least partially responsible for the current tension in the labor market.
The Fed, fiscal policy and inflation
The big news from the Fed was the long-awaited announcement of the âtaperâ of asset purchases. Markets feared the Fed would bow to market pressure, become more hawkish, and raise interest rates early to combat the incorrect but oft-repeated media narrative of âstagflationâ.
At the press conference following the FOMC meeting on Wednesday, November 3, Fed Chairman Powell said: âThe inflation we are seeing is not due to a tight labor market, it is due to shortages, shortages. Additionally, and as we have noted in previous blogs, Powell has stated that the Fed does not have the tools to deal with supply issues (and therefore, by implication, an increase in interest rates n is not appropriate for the inflation we are experiencing). Finally, given the ongoing supply issues, Powell has suggested (and the markets seem to have accepted it) that we may have to wait until Q2 or Q3 2022 before we see a respite from the current high level. inflation. In other words, “transient” now has a delay. Ultimately, Powell seems to have convinced the markets that it will be the âdataâ, not market pressure, that will ultimately determine the path of the interest rates administered by the Fed.
- While we agree with Powell’s version of âtransient,â we believe some of the rise in inflation is lasting, especially with respect to energy. The decision taken in the United States by the Biden administration and those countries at the recent climate summit in Glasgow to accelerate the switch to green energy sources and to move away from fossil fuels is raising the price of these. From an economic point of view, it has to be, otherwise green sources will never be able to compete on prices.
- Shortages are considered to be the main cause of the price increase. Powell, however, was right when he said inflation was due to “very strong demand responding to these shortages.” In our view, the âvery strongâ part of the demand came from fiscal policy, that is, helicopter money (free) sent to most US households and federal unemployment overpayments. Part of the problem revolves around the sudden and dramatic shift in demand towards goods (and away from services) and backing up in ports due to pandemic labor rules. But the tax giveaways must take much of the blame for inflation to artificially increase demand while supply has been blocked.
- To supplement the inflation problem, the administration has issued vaccination warrants for most American workers (currently those with 100 or more employees, but with the intention of including even small businesses), effective from early 2022. If the labor force continues to be short, this only exacerbates the problem of inflation.
- ISM Manufacturing Index: 60.8 (Oct) vs. 61.1 (September) Although still high, the big shock was the drop in new orders to a 15-month low.
- ISM Services Index: The Services Index soared to 66.7 (October) from 61.9 (September). This is good news for Q4 GDP.
- On the other hand, construction spending fell in September (-0.5%) continuing to decline. Residential fell 0.5%. Mortgage applications also fell -3.3% in the last week of October (could it be rising house prices and / or rising mortgage rates?). And pending home sales fell -2.3% in September.
- Consumer sentiment (University of Michigan), often a leading indicator, has not performed well in recent months, and at 71.7, it is approaching territory usually reserved for recessions.
- Coming back to the âtransitoryâ notion of inflation, note the recent spectacular drop in the Baltic Dry index (-51% from 5,650 on October 6 to 2,769 on November 4) (see graph at the top of this blog) . This seems to validate the notion of “transient”, especially if the plunge continues. (This index averages the prices paid for the transport of dry bulk goods on more than 20 major routes. It is considered a leading economic indicator because changes in the index reflect the supply and demand of important raw materials. .)
Faced with supposedly decent jobs data and a Fed promising rate hikes based on economic data, not market pressures, interest rates fell dramatically on the yield curve on Thursday and Friday (November 4 and 5), supporting our long term. believed that rates would stay “lower for longer”.
(Joshua Barone contributed to this blog)