Job data bad | Financial Times

Good morning. It turns out the US is not going to win the World Cup. Another bad prediction by Unhedged, but we will not be discouraged. We now forecast a glorious victory for England, which will instantly close the UK equity discount. Email us: [email protected] & [email protected].

The bad good news on jobs

Stock market bulls have no use for strong job growth just now. A strong economy means a more uncompromising Fed and therefore a higher chance of recession.

In that vein, the topline of Friday’s November payrolls report looked bad, which is to say strong. Average hourly earnings grew at the fastest pace all year. Along with upward revisions to September and October wage data, many concluded it was time to rip up hopes that the labour market will cool without help from a hawkish Fed.

Yet the report was noisy. Some questioned whether, after a sharp drop in the survey response rate, the data should be taken at face value. Others argued that falling hours worked may have skewed the hourly earnings data. Here’s Preston Mui at Employ America:

Average hourly earnings are derived by dividing ‘total dollars spent on payroll’ by ‘total hours worked’, so noisy movements in hours worked are reflected in average earnings. For example, elevated workplace absences due to illness can drag on hours worked while keeping aggregate payroll expenditures elevated, thereby causing average earnings to spike. Sectoral inflection points — like the recent contraction in transportation and warehousing employment — can also lift average earnings if low-wage workers are disproportionately let go

Mui prefers to focus on recent deceleration in other wage measures. That is fair enough; wage growth does look like it’s peaked.

These details are important, the big picture is clear enough. By most measures, the labour market is very tight (though loosening a bit) and wage growth is very hot (though cooling a bit). Some are reassured by the marginal changes in the right direction, but charts like the one below, from Barclays, don’t leave us brimming with confidence that normality is on the horizon:

It’s worth being clear about why wage growth matters to inflation. Here is what Jay Powell thinks, from his speech last week:

Finally, we come to core services other than housing . . . this may be the most important category for understanding the future evolution of core inflation. Because wages make up the largest cost in delivering these services, the labour market holds the key to understanding inflation in this category

The idea that wages are behind rising services prices feels intuitive. You get your hair cut and most of what you pay goes to the hairdresser. The haircut’s price and the hairdresser’s pay are tightly linked.

In reality, though, not all services work this way (car repairs depend on the costs of parts, transit on the cost of fuel, and so on). As we wrote last Thursday, Powell’s claim is at best arguable. The better way to understand the wages-inflation link is that it works through consumption, as Matt Klein lays out in his latest edition of The Overshoot:

It’s not so much that higher wages push up costs for businesses . . . the bigger issue is that employment income is the largest and most reliable source of financing for consumer spending. Wages can rise 1-3 percentage points faster or slower than consumer prices for a variety of reasons — including but not limited to compositional and definitional differences — but larger gaps between the growth rates of wages and prices basically don’t exist outside of WWII and Korean war rationing, the late 1990s productivity boom, and the first year of the pandemic.

High wage growth matters because it sustains above-trend consumption, which is supporting inflation. And high wages are not the only reason consumption is running hot. Consumers still have a lot of savings. Strategas puts the stock of excess savings (relative to pre-pandemic levels) at $1.3tn, which, on current trend, would take some 14 months to deplete. But the Fed cannot take savings out of people’s bank accounts. Its lever for cutting consumption is making the labour market worse for workers, forcing them to draw on dwindling savings until spending comes down too.

The market thinks the Fed will succeed in bringing inflation back to target, and quickly. See the dark blue line in the Barclays chart. The other lines show the market’s past efforts at predicting inflation:

Hence equities’ buoyancy since October. The market is pricing in some sort of soft landing.

There are three main ways it could be wrong. First, the Fed succeeds on inflation, but this takes a while and causes a recession in the mean time. This is Unhedged’s view. Second, the Fed accepts inflation somewhat above its current target, and is lucky enough to dodge both a recession and an inflation spiral. Third is a big, dumb Arthur Burns-style policy mistake, as Ralph Axel of Bank of America argues in a recent note:

We think markets have become too complacent about how simple the trajectory of the Fed, and therefore of markets, will be. The current market view is that it’s a single battle and once victory is declared, the game is over and it’s time to buy . . . 

The main flaw in our view of the 1960s-1970s Fed is the same as today: the Fed wants to do no harm. While today’s Fed recognises the “errors” of its stop-go policy in the last inflation episode, it has already demonstrated its inclination for ongoing dovish choices with its slow transition out of easy policy in 2021 and its desire to approach restrictive rates at a much slower pace while inflation is still very high and jobs are averaging about 300k per month . . . 

In the 60s, the Fed eased after periods of rising unemployment, only to hike rates again and then ease again, which allowed inflation to fester for 15 years in this stop-go approach. We think the Fed is susceptible to repeating these mistakes

We don’t think the Fed will make this mistake. Yes, it will probably raise rates by 50bp instead of 75 at this month’s meeting, and future rate increases could even come in 25bp increments. But that choice is about maintaining optionality, not easing policy. Fed officials are well aware of the dangers of stop-and-go. Don’t overthink it: the biggest risk to markets is that the Fed needs to be tough, and is. (Wu & Armstrong)

One good read

The area near the FT’s office in west Manhattan feels a bit underpopulated these days. It’s not just us.