Employment numbers for December were much weaker than expected with net new job creation at +199K, well below the +422K consensus outlook. In addition, workweeks contracted as factory overtime. But the markets did not react much to it. Instead, because the labor force participation rate (LFPR) continued to be well below its pre-pandemic level and did not budge in December (as expected), the labor market remained tight with wage growth confined to less-skilled sectors, Was breaking into many of them to reverse. This added to concerns about already skyrocketing inflation and sent yields high and high-flying equities low. The real concern here is how the Fed implements policy around ideas of rising inflation (usually met by tighter monetary policy), while economy growth falters (usually met with policy easing).
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Let’s start with ADP’s 807K number from Wednesday. This gave the market the anticipation of a blockbuster report in December. But, as we suggested in earlier blogs, the “shortage” narrative led to a lot of holiday shopping earlier than usual. Johnson Redbook chain store sales data consistently showing with negative comp for the same 2020 week (latest data more than -4%). On a seasonally adjusted (SA) basis, retail
As indicated, the Establishment (payroll) survey was a disappointing +199K (SA). As we have propagated, SA data can be misleading, as discussed below, the pandemic still has a major economic impact, and the pandemic is not seasonal. No Seasonally Adjusted (NSA), installation data was even weaker +72K. Of course, when market bulls don’t get what they want, they end up with data that fits their mantra. In this case, the more volatile household survey showed a SA +651K increase. (That’s potentially a lot of Uber Eats, grub hubs, and door dash drivers!) NSA data, however, at -65K, gives one a not so exuberant experience.
The real key here is the stagnation in the labor force participation rate (LFPR), the percentage of the working-aged population either holding a job or looking for one. It stood at 61.9% in December, which is still well below its pre-pandemic level of 63.4%. And this led to two important developments:
- The U3 unemployment rate fell from 4.2% to 3.9%, not because employment was strong, but because the LFPR was weak. There appears to have been a significant change in attitudes towards work in low-skilled jobs in the US versus pre-pandemic times. Had the LFPR returned to its pre-pandemic levels, as in Canada, the U3 unemployment rate would be north of 6%! (And it’s north of the range near that number.)
- External pay increases have now become widespread. Previously, this was limited to low skilled jobs (leisure/hospitality, retail) but has now broken down – this is due to the LFPR issue. The M/M change in pay, as expected, was +0.8% in the leisure/hospitality sector. But, look at what happened to wages in the following sectors:
- Utilities: +1.8%
- Wholesale trade: +1.0%
- Education/Health Care: +0.8%
- Financials: +0.7%
- Construction: +0.4%
These trends, coupled with continued media coverage of inflation (much of which have been caused by supply issues), a public in arms, and a political class now running for cover, translate into pressure on the Fed to do something. . So far, they have launched a campaign of “less ease”, that is, the “taper” of property purchases. But, more recently, the Fed has reassured the markets through various Fed Governor speeches/interviews, spokespeople, and the release of minutes that interest rates are rising, and much sooner than the market expected. Thus, a rapid increase in Treasury yields. (Of course, equities hate to tighten the Fed.)
The Fed’s Dilemma – Inflation vs. Weak Economy
The problem for the Fed is that we together Inflation and weak economy is:
- The employment survey was taken the week of December 12-18 when concerns over the Omicron version were low/just starting to emerge, and no one was paying attention to those saying that the upcoming holiday celebration could be the reason for the increase in infections. Will be the reason But, of course, there will be concerns like this in January survey week (January 9-15), and weak job growth, along with continued wage increases will keep pressure on the Fed.
- The market reacts to the Fed’s “announcement” of its action, not to the action itself. The 10-year Treasury yield is the benchmark for mortgage rates. It has risen 40 basis points (.4 percentage points) since mid-December due to various “signals” coming from within the Fed (from its low of 1.37% on December 16 to 1.77% on January 7th). Pending home sales were already on top in November (-2.2% m/m and down in four of the last five months). An increase in the 10-year benchmark yield is bound to have a negative impact on mortgage rates and future housing data.
- We take a closer look at weekly jobs data, continuous claims (CC) (benefit received for more than a week), and initial claims (IC). The December CC data are particularly concerning, with nearly a million since Thanksgiving. Same for IC where the NSA numbers jumped from 258K to 315K in the latest weekly data release, still well above its pre-pandemic 200K level (see chart).
- As the quarter progresses, higher and higher levels of Omicron infections continue to impact employment and economic activity. This is already evident in Open Table’s measure of restaurant activity, and we’ve seen it in the “call-in sick” issue, which led to a plethora of airline cancellations over the year-end holidays.
- Auto sales are down nearly 24% Y/Y in December at 12.4 million units (annualized) and have fallen in seven of the past eight months. A “normal” month is 16 million.
- The latest data shows US consumers borrowed $40 billion (consensus $20 billion) in November, after reducing the savings rate to 6.9%, a four-year low, from 10.5% before was in decline. With weak job growth, savings nearly exhausted, and little hope of additional “helicopter money” from the federal government, loan repayments will be a negative for growth in 2022.
- Both the ISM Manufacturing and Services indices fell in December. The manufacturing index fell from 61.1 to an 11-month low of 58.7 (once again, the consensus (60.3) lapsed on the higher side). Services plummeted, slipping from 62.0 to 69.1 (consensus – yes, missed on the high side at 67.0). Last week, the Chicago Fed’s National Activity Index (NAI) for November was at half its October level.
We cannot escape the fact that markets are and have been overly optimistic about economic growth. This is evident from the frequent omissions on the high side of the Businesshala consensus data. In most omissions, the consensus was written at slightly less optimistic numbers for the current month than before, but in almost every case, the actual data proved to be much weaker.
Thus, the Fed has a real dilemma. Politically, they must “fight” inflation that is no longer considered “transient” (even if it really is). That means tightening policy, not just reducing the level of monetary easing. As discussed above, the economy is slowing down at a much faster rate than is normally seen. In such a scenario, actual monetary tightening almost always results in a recession. Economist David Rosenberg recently pointed out that while the yield curve has the flattening shape that currently exists, 100% of the time, (to repeat, 100% of the time) real GDP has slowed in the ensuing year, and averages two percent. numbers.
The chart at the top of this blog shows how equity valuations are out of touch with their historical levels. Thus, it is no surprise that equities have a problem of indigestion. Our view is that, if labor markets do not ease soon (increased LFPR) and show some moderation in wage increases, the Fed will have no choice but to validate the bond market’s rising rate outlook, And this would ultimately be a policy mistake in the face of declining economic growth.
,Joshua Barron contributed to this blog.,