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Weekly Update 11/4/2022: A Ways To Go

  • Payrolls grow
  • Earnings season continues
  • JNJ makes pricey acquisition
  • DuPont abandons expensive offer

Jobs

Nonfarm payrolls rose by 261,000 in October according to Labor Department data released this morning. That was above the consensus view of a gain of 193,000 and compared to an upwardly revised 315,000 gain in September. Job gains were broad based with health care and manufacturing posting solid increases. Nonfarm payrolls are derived from a survey of businesses. Conversely, a survey of households presented a bit of a different picture as the unemployment rate rose by 0.2 percentage points to 3.7%, higher than the 3.6% consensus. Nevertheless, average hourly earnings accelerated in October underlining the leverage job seekers have in the current marketplace. A smaller labor force participation rate is the cause of the earnings bump because less available workers mean that those looking for jobs can demand higher wages to secure their efforts.

U.S. job openings rose in September suggesting there remains fundamental strength in the labor market. According to the Labor Department’s Jobs Openings and Labor Turnover Survey (JOLTS) released Tuesday, the number of available positions rose to 10.7 million in September from a revised 10.3 million in August. The median estimate in a Bloomberg survey of economists called for a drop to 9.8 million. There are now 1.9 available jobs for every person who is unemployed. This is up from 1.7 in August. The persistent imbalance between labor supply and demand continues to torment the Fed in their efforts to bring down inflation by underpinning wage growth and fueling a wider push toward higher prices. The quits rate, which measures those who voluntarily leave their jobs as a share of total employment, held at 2.7%.

Initial unemployment claims fell by 1,000 to 217,000 in the week ended October 29 according to the Labor Department. The median estimate in a Bloomberg survey of economists called for 220,000 new applicants. This data is timelier than the monthly payroll figure suggesting that things still remain quite tight in the jobs market. Another headwind is U.S. productivity barely rose in the third quarter after steep declines in the first half of the year. Productivity, or nonfarm business employee output per hour, increased at a 0.3% annual rate in the third quarter, according to Labor Department figures Thursday. Firms often adopt new technologies or invest in equipment to make their workers more productive and help offset the inflationary impact of wage increases. Compared to a year ago, productivity was down 1.4%. These productivity figures can be volatile quarter-to-quarter and the pandemic definitely skewed such data for the past few years. Nevertheless, there are important ramifications for the economy in the long-run if it has entered a state of decline.

The Fed and rates

On Wednesday, the Federal Open Market Committee decided to raise the benchmark federal funds rate by 75 basis points (0.75%) in order to combat persistent inflation. It was the fourth consecutive 75 basis point increase and lifts the target range for fed funds to 3.75%-4.00%. The statement that accompanied the decision was decidedly “dovish” enticing investors that the long-awaited “Fed pivot” to less restrictive increases was about to begin. Part of the statement read: “In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.” Since many of us do not have a degree in morphology, imaginations ran wild. This must be the moment when a more accommodative Fed would come to the forefront and save the markets, right? Well, no. Instead of pretending that market participants have an advance degree in morphology, the conclusion should have been that not much had changed. Weeks ago, Vice Chair Lael Brainard said basically the same thing as this statement. In fact, we wouldn’t be surprised if she was the author of these minutes! During the post-meeting press conference, it was up to Fed Chairman Jerome Powell to clarify what was really meant. “The question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive,” he said. Mr. Powell also warned that reducing the size of rate increases didn’t mean the Fed thought it was close to pivoting away from raising rates. “It is very premature to be thinking about pausing,” said Mr. Powell. “We think we have a ways to go.” Whether or not one agrees with his assessment, it does not matter, the fact is the message has not changed. In fact, it was a way to signal to the markets that, yes, the Fed is thinking about the cumulative effect of monetary policy which, infamously, has been known to work with long and variable lags. But it does not mean that it is time to take the foot off the brake.

This has been a rude awakening for many investors who thought that the job of the Federal Reserve was to make stock prices go up. That is not nor has it ever been one of their mandates. In fact, if one actually listens to what the Fed chair said yesterday, one would understand their goal. It is to provide a stable level of prices. Why? It helps businesses plan better for investments and other future variables. It supports household efforts to increase their standard of living especially when coupled with a stable and dependable paycheck (no surprise the Fed’s other mandate is full employment). Because it has been empirically proven that when inflation is somewhere around 2%, stocks do very well. And this is true not only in the U.S. but in many developed countries around the world. It may not look like it, but the Fed is actually trying to help stock investors—at least those who have a long-term view. Take a look at history. When then Fed Chairman Paul Volcker led the charge to kill inflation in the early 1980’s, he had to raise the benchmark rate very aggressively to accomplish his goal. The S&P 500 rose from 98 to at the beginning of 1982 to 2120 by the end of 1999 which marked the dot-com implosion. That’s a return of over 2,000%. The economy certainly had its boom and busts during that time, but more stable prices was an ongoing characteristic as the Fed used its tools to beat inflation down to about 3.5% by the latter half of the 1980s. Compare that to the decade of the 1970s which were averaged inflation closer to 7% and was characterized by equity markets that basically were flat. Past results are no guarantee of future returns, but the Fed and smart investors know that inflation must be tamed one way or another for the intrinsic value of corporate cash flows (which serve as the backbone of valuations) to move appreciably higher.

Mr. Powell and others have voluntarily taken the blame for letting inflation get out of control in the first place. They waited too long to raise rates and remove quantitative easing. As a result, they see the only option is to use their blunt instrument tool—interest rates—to help aggregate demand be more in-line with aggregate supply. Sometimes the medicine tastes terrible, but it is what a sick patient needs to either feel better or not get worse. Rate hikes are a bitter pill but one that is the least bad of other bad options at this point (a return to the gold standard anyone?). The specter of past mistakes by the Fed in the 1970s still haunt that establishment and, though an argument can be made to pause the rate hikes, the luxury of time is not something the Fed has. Once inflation, especially in services industries which comprise the bulk of U.S. GDP, becomes “sticky,” it is hard to eradicate. The labor numbers discussed above are clear evidence of why the Fed is willing to over-tighten financial conditions. Too tight might lead to a recession, but they can always turn right around and start cutting. Too little and inflation roars out of control and we have a potential return to the markets of the 1970s—no thanks.

The Bank of England raised its key interest rate by 0.75 percentage point yesterday. This was the largest increase since 1989. The central bank raised its benchmark lending rate to 3% from 2.25%, taking it to the highest level since November 2008. Despite the bank’s eighth consecutive interest-rate increase, its Monetary Policy Committee signaled that it doesn’t expect to continue to increase borrowing costs by as much as investors anticipate taming inflation. “The MPC’s latest projections describe a very challenging outlook for the U.K. economy,” the BOE said in a statement. “It is expected to be in recession for a prolonged period.” So, the trend towards higher rates is not unique here in the U.S.

The next Fed meeting will conclude on December 14. The expectation is that there will be another interest rate increase. Futures markets are currently pricing in the chance of a 50 basis point (0.50%) increase which would bring the upper end of their target range for the benchmark federal funds rate to 4.50%. Wrote Bloomberg Economics US Chief Economist Anna Wong: “The jobs report for October sends mixed signals about the labor market, with one survey showing robust job gains while another shows a big jump in unemployment. Filtering the noise in the data, our takeaway is that the labor market is still very tight, and much adjustment still needs to occur before unemployment is close to a neutral level. We expect that the Fed will ultimately have to raise rates to 5% next year.” Remember, at the beginning of the year, that target was 0.00%-0.25% emphasizing the sharp increase that has occurred in 2022. At the beginning of the year, futures markets were pricing in a fed funds rate range of 0.75%-1.00% by the end of 2022—my how things have changed! Next month, we will also get the latest Fed projections for GDP, unemployment, inflation and the always interesting “dot plot” graphically depicting where Fed governors think fed funds will be in subsequent years. There are less than two months left in the year, yet the markets could still have plenty of fireworks before the books are closed on 2022. As always, stay tuned!!

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