Markets are struggling to grasp the realities of the new economic dynamics. Inflation is expected to be announced next week at 8.8% while unemployment is only 3.6%, near post-pandemic lows. In addition, second quarter GDP is projected to be negative 2.1% according to the Atlanta Fed. The first quarter was negative 1%. Two consecutive quarters of negative GDP growth signify a recession.
Barry Ritholtz of Bloomberg pronounced “we have never been in a recession without rising unemployment”
While top line inflation is 8.8%, core inflation (without food and fuel) is only 6%, still far above the Fed’s 2% target.
However, says Tom Keene of Bloomberg, “We are not living core inflation… we are living almost double-digit headline inflation and it hurts.” (1)
The estimate is for 268k new jobs to have been created in June. The unemployment rate is expected to stay at 3.6%. Jobs creation in May was 390k.
Priya Misra, TD Securities Economist
“We think the labor market is slowing and the Fed is focused on inflation. The Fed wants the labor market to slow.” Says Misra.
“Until inflation gets closer to 2% I don’t think the Fed will change its focus on inflation. Inflation is almost 9% now.
The market is going to be waiting for the fed to blink and cut rates; I don’t think inflation is going to let them.”
On Thursday Fed governors Waller and Bullard announced their support for rate hikes of 75bp in order to get ahead of inflation, regardless of recession risks.
Waller explained, “Policy must get to restrictive territory to combat the hottest inflation in 40 years, even if it means impacting growth.”
Last month it was memorable that Rick Rieder of Blackrock said he would not be surprised to see a negative labor print in July’s unemployment report.
“You are starting to see some signs of consumer spending slowing down.” Kailey Leinz of Bloomberg
“Consensus reports for earnings are too high.” Added Jon Ferro of Bloomberg.
Randall Kroszner, former fed Chicago and currently Chicago-Booth School economics professor
Kroszner starts out saying, “The Question is will inflation persist over 3-5 years?”
Ferro asks, “What makes the fed pause?”
“I don’t think they are pausing any time soon.” Kroszner continues, “Powell has made it clear its gonna take a lot for the fed to pause. The key is the focus on inflation and inflation expectations, they need to move now (to raise rates)… the consequences of a slowing economy comes later.”
Worldwide inflation is worsening. Brazil’s inflation is near 12% and UK households are bracing for high energy prices during the coming winter. In Argentina, prices jumped 20% overnight causing panic among consumers and politicians.
830am July Nonfarm Payroll Report
372k jobs created
Unemployment rate of 3.6%
Earnings growth 5.1% yoy
Everyone agrees, “This will drive fed to boost rates another 75bps at end of the month…”
Michael Mckee, Bloomberg economist, points out some positive numbers including that the unemployment rate for African Americans fell. He adds though that its curious that the Labor Force Participation rate fell. The household survey showed the Labor force fell 350k, even as the economy added jobs.
“A buoyant jobs report” announced Tom Keene.
Kroszner interjects, “The Fed is trying to move expeditiously. Nothing in this report that’s gonna slow them down.”
Kroszner adds, “This is a pretty robust jobs market but I do see that weakening by the fall. There is a large number of people that are not going to come back into the job market, especially older people.
Since the Spring of 2022, the market seems driven by the expectation that the Fed will capitulate and lower rates to support markets and the economy. “It’s a matter of “if” the fed blinks, it used to be the expectation that the Fed will pause in September.” Said Leinz
Keene adds, “Immense amount of uncertainty going forward.”
One of the factors driving uncertainty is how much a slowing economy and higher commodity prices will affect corporate earnings. “Earnings revisions have started being revised down, a lot of it based on margin pressure.” Michael Casper of Bloomberg Intelligence “There’s gonna need to be a lot of damage to the earnings line. Companies are adapting.”
“The labor market is hot and the fed wants it to cool down.” Leinz adds.
Mckee explains the “report was much better than anyone expected. We are seeing job growth without a lot of wage growth.”
Rick Rieder, Blackrock CIO
Mohamed El-Erian, Cambridge, former Pimco CEO
These two professionals give a holistic picture of the challenges investors face in the months ahead as they talk to Jon Ferro on Bloomberg.
El-Erian “It’s great to see 3.6% unemployment rate, great to see job creation…but one disappointment is we need to see Labor Force Participation (LFP) rate go up.” LFP measures how many workers are in the economy. During COVID many workers left the labor force. “More workers coming in would be a positive.”
“The Household survey down 350k”, showing fewer workers in the labor force. Rieder adds, “It has been pretty weak for last few months. Clearly a transition taking place. It’s no question the economy is slowing…”
Rieder continues, “There is something funky going on. More solid report than I would have thought it would be.”
El-Erian suggests, “This Fed isn’t stopping; the Fed needs to catch up… they are behind the curve.”
Rieder warns, “I am worried that they may break something as rates become restrictive. We see a significantly slowing economy, I do think they will have to slow down in the fall.”
When asked about his level of risk aversion, El-Erian said, “I am pretty risk averse. What would make me have a more constructive view is if inflation proves to be ‘less sticky’.”
Several factors point to inflation staying ‘more sticky’ at higher levels for a long period of time including the war in the Ukraine, higher global temperatures affecting crops and food supplies, corporations buying houses as housing supplies remain constricted. In addition, Rieder points to structural changes in the economy after COVID.
“We are going through a deglobalization that is real and that will increase prices. At the margin inflation can come down but when you are bringing your businesses back onshore it will affect financials for companies.”
El-Erian chimes in about the continuing impact of supply chain disruptions from China. “It is going to continue to be a problem if China doesn’t change its zero covid policy and use MRNA vaccines… it is built into the continuing economic disruption.”
Rieder points out that companies will be driven to focus on technology. “Companies in an inflationary world are going to have to invest in technology to improve performance.”
El-Erian warns, “We are gonna have an avalanche of downward revisions in earnings in the next 3 months.”
Though economic weakness has not shown up in the jobs report, elevated levels of inflation will force the Fed to continue raising rates into the Fall of 2022, and possibly beyond. This has implications for the future direction of markets.
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