The narrative is resolute
That though prices did overshoot
They’re certain to fall
And that, above all,
The Fed’s in control, absolute
However, concern is now growing
That growth round the world’s started slowing
Though Friday’s report
On jobs was the sort
To help the bull market keep going
Clearly, my concerns over a weak payroll report were misplaced as Friday’s data was strong on every front, although perhaps too strong on some. Nonfarm payrolls grew a robust 943K with net revisions higher of 119K for the past two months. The Unemployment Rate crashed to 5.4%, down one-half percent, and Average Hourly Earnings rose 4.0% Y/Y. It is the last of these that may generate some concern, at least from the perspective of the transitory inflation story.
While it is unambiguously good news for the working population that their wages are rising, something that has been absent for the past two decades, as with Newton’s first law (every action has an equal and opposite reaction) the direct result of rising wages tends to be rising prices. So, while getting paid more is good, if the things one buys cost more, the net impact may not be as positive. And in fact, consider that while the 4.0% annual rise is the highest (excluding the distortions immediately following the Covid-19 lockdowns) in the series since at least the turn of the century, when compared to the most recent CPI data (you remember, 5.4%) we find that the average employee continues to fall behind on a real basis.
When discussing inflation, notice that the Fed harps on things like used car prices or hotel prices as the key drivers of the recent rise in the data. They also tend to explain that commodity prices play a role, and that is something they cannot control. But when was the last time Chairman Powell talked about rapidly rising wages or housing prices as an underlying cause of inflation? In fact, when asked about whether the Fed should begin tapering mortgage-backed securities purchases sooner because of rapidly rising house prices, he claimed the Fed’s purchases have no impact on house prices, but rather it was things like the temporary jump in lumber prices that were the problem. Oh yeah, and see, lumber prices have fallen back down so there is nothing to worry about.
Of course, wages are not part of CPI directly. Rising wages are reflected in the rising prices of everything as companies both large and small find it necessary to raise prices to maintain their profitability. Certainly, there are some companies that have more pricing power than others and so are quicker to raise prices, but in the end, rising wages result in one of two things, higher prices or lower margins, and oftentimes both. In the broad scheme of things, neither of these outcomes is particularly positive for generating real economic growth, which is arguably the goal of all monetary policies.
Consider, to the extent rising wages force companies to raise the price of their product or service, the result is an upward bias in inflation that is independent of the price of oil or lumber or copper. In fact, one of the key features of the past 40 years of disinflation has been the fact that labor’s share of the economic pie has fallen substantially compared to that of capital. This has been the result of the globalization of the workforce as the addition of more than 1 billion new workers from developing nations was sufficient to keep downward pressure on wages.
Arguably, this has also been one of the key reasons corporate profit margins have risen and stock prices along with them. Now consider what would happen if that very long-term trend was in the process of reversing. There is a likelihood of rising prices of goods and services, otherwise known as inflation. There is also a likelihood of a revaluation of equity prices if margins start to decline. And nothing helps margins decline like rising labor costs.
Consider, also, this is the sticky type of inflation, exactly the opposite of all the transitory claims. This is the widely (and rightly) feared wage-price spiral. I am not saying this is the current situation, at least not yet, but that things are falling into place that could easily result in this outcome.
Now put yourself in Chairman Powell’s shoes. Prices have begun rising more rapidly as companies respond to rising wage pressures. The employment situation has been improving more rapidly so there is less concern over the attainment of that part of your mandate. But…the amount of leverage in the system is astronomical with government debt running at record high levels (Federal government at 127%) and all debt, including household and corporate at 400% of GDP. Do you believe that the economy can withstand higher interest rates of any substance? After all, in order to tackle inflation, real rates need to be positive. What do you think would happen if the Fed raised rates to 6%? And this is my point as to why the Fed has painted themselves into the proverbial corner. They cannot possibly respond to inflation with their “tools” because the negative ramifications would be far too large to withstand. It is also why I don’t’ believe the Fed will make any substantive policy changes despite all the tapering talk. They simply can’t afford to.
Ok, on to the markets. One of the notable things overnight was the flash crash in the price of gold, which tumbled $73 as the session began on a huge sell order in the futures market, although has since regained $54 and is currently down 1.1% from Friday’s close. The other things was the release of Chinese CPI (1.0%) and PPI (9.0%), both of which printed a few ticks higher than expected. Obviously, there is not nearly as much pass-through domestically from producer to consumer prices in China, but that tends to be a result of the fact that consumption is a much smaller share of the Chinese economy. However, higher prices on the production side, despite the government’s efforts to stop commodity speculation and hoarding, does not bode well for the transitory story. And while discussing EMG inflation readings, early this morning we saw Brazil (1.45% M/M) and Mexico (5.86% Y/Y) both print higher than forecast results. Certainly, it is no surprise that both central banks are in tightening mode.
A quick peak at equity markets showed Asia performed reasonably well (Nikkei +0.3%, Hang Seng +0.4%, Shanghai +1.0%) although Europe has been struggling a bit (DAX -0.2%, CAC -0.1%, FTSE 100 -0.4%). US futures, meanwhile, are either side of unchanged with very modest moves.
Treasury yields have given back 2 basis points from Friday’s post-NFP surge of 7.5bps, although there are many who continue to believe the short-term down trend has been ended. European sovereigns are also rallying a bit, with Bunds (-1.3bps), OATs (-1.3bps) and Gilts (-3.5bps) leading a screen that has seen every European bond rally today.
Commodity prices are perhaps the most interesting as oil prices have fallen quite sharply (-4.0%) with WTI back to $65.50/bbl, its lowest level since late May. This appears to be a recognition of the growth of the Delta variant and how more and more nations are responding with another wave of lockdowns and restrictions on movement, thus less travel and overall economic activity. As such, it should be no surprise that copper (-1.5%) is lower or that the metals space as a whole is under pressure.
Interestingly, the dollar is not showing a clear trend at all today, with gainers and losers about evenly mixed and no particularly large moves. In the G10, NOK (-0.3%) is the laggard, clearly impacted by oil’s decline, but away from that, the mix is basically +/- 0.1%, in other words, no real change. In the emerging markets, ZAR (+0.3%) is the leader, although this appears more to be a response to its sharp weakness last week than to any specific news. And that is the only EMG currency that moved more than 0.2%, again, demonstrating very little in the way of new information.
Data this week brings CPI amongst a bunch of lesser numbers:
|Today||JOLTS Jobs Openings||9.27M|
|Tuesday||NFIB Small Biz Optimism||102.0|
|Unit Labor Costs||0.9%|
|Wednesday||CPI||0.5% (5.3% Y/Y)|
|-ex food & energy||0.4% (4.3% Y/Y)|
|PPI||0.6% (7.1% Y/Y)|
|-ex food & energy||0.5% (5.6% Y/Y)|
At this point, the response to the CPI data will be either of the following; a high number will be ignored (transitory remember), and a low number will be proof they are correct. So, while we may all be suffering, the narrative will have no such problems!
There are a handful of Fed speakers this week as well, with the two most hawkish voices (Mester and George) on the calendar. Right now, the narrative has evolved to tapering is part of the conversation and Jackson Hole will give us more clarity. The market is pricing the first rate hike by December 2022 based on the recent commentary. We shall see. Until then, I don’t anticipate a great deal as many desks will be thinly staffed due to summer vacations. Just be careful if you have a large amount to execute.
Good luck and stay safe