As Fed grapples with inflation / recession dilemma, markets show signs of indigestion

Employment figures for December were much weaker than expected with net new job creation at + 199K, well below the consensus of + 422K. In addition, the work week has contracted, as has overtime in the factory. But the markets haven’t reacted much to this. Instead, given that the Labor Force Participation Rate (LFPR) remained well below its pre-pandemic level and did not budge in December (as expected), the labor market is remained stretched with wage growth, which had been confined to less skilled sectors, breaking upward in several of them. This raised already very high inflation concerns and pushed up yields and lower top-flight stocks. The real concern here is how the Fed maneuvers its policy around rising inflationary considerations (normally satisfied by tighter monetary policy) as economic growth weakens (normally satisfied by policy easing).

Ugly job details

Let’s start with Wednesday’s ADP number 807K. This gave the markets expectations for a successful December report. But, as we have suggested in previous blogs, a lot of holiday shopping has been happening earlier than normal due to the ‘shortage’ story. Johnson Redbook chain store sales data is constantly showing with negative comparisons for the same weeks 2020 (latest data is now above -4%). On a seasonally adjusted (SA) basis, the retail trade

the sector presented itself without net new jobs (-2.1K).

As noted, the establishment survey (payroll) was a disappointing + 199K (SA). As we preached, SA data can be misleading because, as noted below, the pandemic still has great economic influence and the pandemic is not seasonal. Unadjusted for seasonality (NSA), the facility’s data was even lower by + 72K. Of course, when the bulls in the market don’t get what they want, they find the data that matches their mantra. In this case, the much more volatile household survey showed an increase of SA + 651K. (That’s potentially a lot of Uber Eats, Grub Hub, and Door Dash pilots!) NSA data, however, at -65K leaves a not-so-exuberant feeling.

The real key here is the stagnation of the Labor Market Participation Rate (LFPR), the percentage of the working-age population having a job or seeking one. It remained at 61.9% in December, still well below its pre-pandemic level of 63.4%. And this caused two important developments:

  1. 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 attitude towards working in low-skilled jobs in America compared to the pre-pandemic times. If the LFPR had returned to its pre-pandemic level, as it did in Canada, the U3 unemployment rate would be north of 6%! (And that’s near that number north of the border.)
  2. Inordinate wage growth has now become widespread. Previously it was confined to less skilled jobs (leisure / hospitality, retail), but it has now exploded – due to the LFPR issue. The M / M variation of wages was, as expected, + 0.8% in the leisure / hotel sector. But, look what happened to wages in the following industries:
  • Public services: + 1.8%
  • Wholesale trade: + 1.0%
  • Education / Health: + 0.8%
  • Financial: + 0.7%
  • Building: + 0.4%

Add to these trends continued media coverage of inflation (much of which has been caused by supply issues), an armed public and a political class now looking to cover themselves up, this translates into pressure on the Fed to do something. So far, they have embarked on a campaign of “less ease”, that is to say, “decrease” in asset purchases. But, of late, the Fed, through various speeches / interviews with the Fed governor, spokespersons, and minute books, has convinced the markets that interest rates will rise, and more. sooner than expected. Thus, the rapid rise in Treasury yields. (Of course, stocks hate the Fed’s tightening.)

The Fed’s Dilemma – Inflation vs. Weaker Economy

The problem for the Fed is that we simultaneously have inflation AND a weakening economy:

  • The Jobs Survey was conducted the week of December 12-18 when concerns about the omicron variant were low / just starting to emerge, and no one was paying attention to those saying the upcoming festivities would spike. infections. But, for sure, the January survey week (January 9-15) will contain such concerns, and weakening employment growth, along with continued wage hikes, will keep the pressure on the market. Fed.
  • Markets are responding to the Fed’s “announcement” of its action, not the action itself. The 10-year Treasury yield is the benchmark for mortgage rates. It has risen 40 basis points (0.4 percentage point) since mid-December (from its low of 1.37% on December 16 to a high of 1.77% on January 7) due to various “clues” from inside the Fed. Pending home sales were already on top in November (-2.2% M / M and down in four of the last five months). The rise in the benchmark 10-year yield will certainly have a negative impact on mortgage rates and future housing data.
  • We closely monitor weekly data on Jobs, Continuing Claims (CC) (those receiving benefits for more than a week) and Initial Claims (IC). Of particular concern is December’s CC data, up nearly a million since Thanksgiving. Similar for CIs where the NSA number rose from 258K to 315K in the last weekly data release, still significantly above its pre-pandemic level of 200K (see graph).
  • High and rising levels of omicron infections can only weigh on jobs and economic activity as the quarter progresses. This is already evident in the measurement of Open Table restaurant activity, and we have seen it in the “sick calls” problem which caused a plethora of airline cancellations during the end of the holidays. year.
  • Auto sales, at 12.4 million units (annualized) in December, are down nearly 24% year-on-year and have fallen in seven of the past eight months. A “normal” month is 16 million.
  • The latest data shows that U.S. consumers borrowed $ 40 billion in November (consensus was $ 20 billion), after slashing the savings rate to 6.9%, a four-year low, from 10.5% earlier in the fall. With weak job growth, savings nearly depleted, and little hope of additional “helicopter money” from the federal government, debt repayment will be negative for growth in 2022.
  • The ISM manufacturing and services indexes plunged in December. The manufacturing index fell to an 11-month low of 58.7 from 61.1 (again the consensus (60.3) missed the high). The serves were hit, sliding to 62.0 from 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 of its October level.


We cannot escape the fact that the markets are and have been overly optimistic about economic growth. This is clear from the constant failures on the high side of the Bloomberg consensus data. In most failures, the consensus had slipped into slightly less bullish numbers for the current month than the month before, but in almost all cases the actual data turned out to be much weaker.

So the Fed is faced with a real dilemma. Politically, they must “fight” inflation which is no longer considered “transitory” (even if it really is). This means tightening policy, not just reducing the level of monetary easing. As noted above, the economy is slowing down at a much faster rate than is commonly believed. In such a scenario, actual monetary tightening almost always results in a recession. Economist David Rosenberg recently pointed out that when the yield curve has the flattened shape that it currently exists, 100% of the time, (repeat, 100% of the time) real GDP slowed down over the next year, and in average of two percent. points.

The chart at the top of this blog shows how out of touch stock valuations are from their historical levels. So, it is no wonder that stocks are plagued with indigestion. Our view is that if labor markets do not ease quickly (LFPR rise) and show some moderation in wage growth, the Fed will have no choice but to validate the vision of rising bond market rates, and that will ultimately be a policy error in a scenario of slower economic growth.

(Joshua Barone contributed to this blog.)