In the 1970s the Fed led by Chair Arthur Burns shifted policy from hiking rates to fight inflation to cutting rates to fight recession. The result of this policy change was inflation growth slowed for a few months but then reaccelerated to higher levels causing more pain, more rate hikes and more recessions.
“This is the prospect of a flip-flopping Fed…” injected Jon Ferro of Bloomberg. (1)
“People are looking for the fed to cut as soon as they stop raising rates in order to counter a slowing economy” adds Lisa Abramowicz
The Jobs number is expected to come in at 250k new jobs added, though some estimates are as low as 50k. This is compared to 372k jobs created in the previous jobs report.
The Labor Force Participation rate has been declining over the past few months showing people are leaving the labor force.
Abramowicz added, “The emerging goldilocks message is misplaced…”
Stocks have rallied since June with the SP500 up 13% but several US broker dealers have indicated its time to reallocate…
“HSBC Bank Plc’s Max Kettner sees a painful end to this summer’s rally, and recommends abandoning equities and government bonds and hiding in cash on mounting risks to economic growth.” (4)
Bernstein and Goldman Sachs added their voice to the caution… “the strategists said they’re “not convinced that we are past the ‘true’ trough in positioning just yet, and we think the path from here is likely to become more dependent on macroeconomic data.” (5)
Question is ‘what is the risk to the downside?’ and what is possibility of a shift in Fed policy from tightening to loosening.
During the last week several Fed officials stated that Fed rate hikes and tightening will continue. Minneapolis Fed President Kashkari explained:
“The committee is united in our determination to get inflation back down to 2 percent, and I think we’re going to continue to do what we need to do until we are convinced that inflation is well on its way back down to 2 percent — and we are a long way away from that.”
“Investors took that as a sign that the central bank was likely to slow rate moves sharply in the coming months as the economy slows. In fact, bond market pricing suggests that investors think officials may even begin to cut interest rates next year.”
“I don’t know what the bond market is looking at in reaching that conclusion,” Mr. Kashkari said, adding that the bar would be “very, very high” to lower rates.
Kashkari was one of the most dovish members of the FOMC prior to the current hiking cycle. (2)
Ellen Zentner, Morgan Stanley
Tom Keene of Bloomberg asked, “How is American consumer faring?”
Zentner responded, “Labor income is the number one driver of consumption. We want to see LFP higher today. Our research has indicated we need 90k jobs created to keep the unemployment rate steady. A strong labor market poses challenges to the Fed.
If we don’t see a slackening in the labor market, that’s scary to me, because that means the fed will have to keep hiking rates… We are running a hot labor market.”
Zentner added, “We have been studying the impacts of ‘long covid’, and we might have a real problem with a large number of people who are going to be permanently unemployable.” This impacts the size of the labor force.
The UK has a large body of research on the study of long covid.
The CPI rate showed 9.1% growth last month. The Fed is raising rates in an effort to lower inflation. (6) As early as March of 2022, when Powell was asked about the possibility the Fed will cause a recession due to rate hikes and financial tightening. Recessions typically slow and reduce inflation. (7)
Yield curve inversion (the difference in rates between the 2yr treasury bond and the 10 yr treasury bond) is a precurser of a recession. The ‘2s10s’ has typically foretold recessions are imminent.
In the past month, the Yield Curve inverted -37bps, the widest level in 22 years. (1)
Randy Krozner, former Fed official, University of Chicago
“Is the fed flying blind now, do they have a plan or are they making it up as they go?” asked Tom Keene. (1)
Krozner responded, “The fed isn’t sure about the dynamics, but one thing is sure, if you raise rates you crimp demand. Powell has made it very clear what direction they are headed.”
Abramowicz asked, “Mohamed El-Erian warned of 70s style flipflop on the part of the Fed; how likely is that do you think?”
“The Fed is well aware of that… the Market is too sanguine about the fed reducing rates and many fed officials warned against this.” Said Krozner.
Keene asked, “Are we fully employed?”
Michael Mckee, Bloomberg economist answered, “If you look at the math of it its hard to disagree. The unemployment rate is low, people who want to work are working.”
830am… the Non-Farm Payrolls Report is released, and shock rolls across the studio…
528k jobs created, vs an estimate 250k
Unemployment falls to 3.5%, down from 3.6% (8)
“This is a very strong payroll report…” says McKee.
Ferro noted “The 2yr yield moved up 14bp immediately on the report.”
Stocks fell as market participants priced in the increased likelihood that the Fed will continue rate hikes to slow the economy.
The report also showed that worker’s earnings rose .5% m/m vs .3% expected. (8) This poses a problem for the Fed because it feeds their fear of a possible wage-price spiral.
The report also showed a decline in labor force of 63,000 and a decline in the Labor Force Participation rate to 62.1%, down from 62.2%.
Asked about the report, Krozner added, “Its really clear the Fed is on a path to continue to raise rates… a hike of 75 bp is on the table for the next meeting. The Fed is worried about inflation becoming entrenched.”
After the report the Yield Curve inversion had worsened to negative 43bps.
Mohamed El-Erian, Queens College, former CEO of PIMCO
“This is a very strong report. Really good news for the White House on the economy, but the Fed is not going to like this report. The report makes Powell’s comment that the rate is at neutral, comical.” (1)
“How can we be at neutral?” asked Ferro.
El-Erian explained, “We cannot. That was an unscripted, off-the-cuff comment. Five or six Fed officials have walked back that comment. A lot can happen between now and September, but this isn’t going to help the feds credibility.”
“The 5.2% y/y wage increase number is very important, now we are seeing wages pick up as people are leaving the Labor Force. Wage inflation will be another sticky driver of long-term inflation and is a real challenge.”
El-Erian added, “This is a strong economy, we are not in recession, but the Fed is behind the curve in its fight against inflation.”
Rick Rieder, Blackrock
“This is a stunning number,” says Rieder. “Its interesting compared to the Jolts information and the recent increase in layoffs. You have to assume the fed is going to do 75bps in September.” (1)
Labor Force Participation fell from 62.2% to 62.1%
In June the labor force lost 353k workers, in July lost 63k…
A recent Study (9) discussed the idea that perhaps the increase in jobs since the Fall of 2021 reflects a trend of people working multiple jobs in order to compensate for rising inflation. (3) Jobs in the Non-Farm Payrolls report and Jolts data do not reflect what kind of job it is… it may be Part Time or Full Time, seasonal or permanent. There is no way to tell… This phenomenon can explain how recent jobs reports have shown an increase in hiring, even as the Labor Force Participation rate declined showing large numbers of people leaving the workforce.
“Many people have already reined in spending where they can, while others have tapped their pandemic savings to cover the rising cost of food, gas, rent and other necessities. Yet the highest inflation in 40 years is weighing heavily on millions of households. Three-quarters of middle-income Americans say they don’t earn enough to pay for the cost of living, according to a recent survey.”
“At the end of the day, there are only so many credit cards you can load up and things you can avoid spending on before you come to the reality that maybe you have to pick up a second job,” Columbia Business School professor Mark Cohen told CBS MoneyWatch. “It’s about how much do you bring in every month, how much do you spend — if you’re in a deficit position, you have to find another job or an additional job.”
“More Americans than ever hold two full-time jobs, amounting to more than 70 hours of work a week. In June, 426,000 people were working two full-time positions, compared to 308,000 in February 2020, according to federal labor data.” This number is likely higher given the growth of the gig economy. (9)
During the recessions of the 1970s, jobs numbers continued to increase even as the economy was in recession. Normally in recessions, unemployment rises and hiring falls prior to recessions. It is possible rising inflation changes those dynamics and this calls into question the utility using Jobs Reports as a real gauge of the health of the economy.
Either way, an increase in hiring indicates the Fed must raise rates more in order to slow the economy, and to slow the growth of inflation. The market does not appear to be reflecting this reality.
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2022-141936 exp 8/24
- Bloomberg surveillance 8/5/2022 https://www.bloomberg.com/news/videos/2022-08-08/-bloomberg-surveillance-simulcast-full-show-8-05-2022?sref=qbSjPdvo