If you’ve been watching US economic data recently and find it all very confusing, let me reassure you. So do I. It’s not your fault …it really is confusing. This week, I’ll try to make sense of it all and draw some conclusions for bonds and equities.
There are two distinct but related areas of confusion.
First of all the US labour market has been super tight. Viewed from several different angles the message has been the same: there is strong demand for workers and not enough supply.
We know what happens when demand exceeds supply: prices (in this case wages) go up. Indeed that’s exactly what has happened. Wage inflation accelerated throughout most of last year. But the latest numbers have slowed. Why?
That’s the bigger picture. But we also had conflicting data last week. Most people, including me, thought the US economy was slowing down. The Federal Reserve has been aggressively raising interest rates, the housing market is in deep recession and although consumers have pots of unspent funds from Covid – the so called Covid piggy banks – these have been drawn down and other assets have been eroded by inflation.
Indeed, jobs were being lost, layoffs had extended well beyond the headline grabbing cuts announced by tech companies. On one measure, layoffs were the highest since the Global Financial Crisis (excluding the Covid period).
And then WHAM. Half a million jobs were apparently created in January. And the background data were all strong too: hours worked jumped, unemployment fell even further and more people joined the labour force. Shortly after those figures stunned the market, a closely watched survey of US services jumped, in marked contrast to other surveys.
So what on earth is going on?
First, wages. I confess to being surprised by the slowdown in wage inflation. It’s still strong, at least in cash terms, at 5% plus, but it has slowed from early 2022. The most likely interpretation is that there was an initial surge when lockdown ended and firms tried desperately to recruit some of the 20 million workers fired during Covid. Restaurants and hotels for example had lots of demand, were able to raise prices and were competing hard for staff. The labour market is still hot but it has come off the boil.
Meanwhile, of course, inflation has come down as commodity prices and supply constraints have eased.
If that’s true, the Federal Reserve has to keep on raising interest rates until the labour market cools properly.
But what about last week’s huge jump in payroll employment? Let’s put it into context. If we describe the number as a 0.3% increase in employment, it doesn’t sound so scary. Note also that January is always a difficult month to estimate. It followed a month with very cold weather in key regions like Florida. Seasonal factors are tricky and we have lots of technical influxes.
But what about those conflicting surveys? It’s clear that different parts of the economy are moving at a very different pace. Manufacturers are struggling to cut inventory. Housing is very, very weak, though house builders had been rushing to complete homes before prices dropped further. But many service areas are booming. Given the weather and the normal problems of measuring the economy at this time of year, the result has been conflicting signals.
So what does all this mean? I am confident that the data last week do not accurately reflect the US economy. It isn’t booming. But clearly it isn’t on the verge of recession either.
Having reduced the pace of rate hikes to 25 bps a meeting, the Fed are now in no position to pause their tightening, still less pivot to lower rates. Can we therefore expect the bear market in bonds to resume? I’m not so sure. Real rates as measured by the yield on Treasury inflation protected securities look generous to me – well over 1% – and as the Fed has made it clear that they intend to get inflation down – and the market believes them – that make conventional bonds look reasonably attractive. Not a steal for sure, but still OK.
As for equities, I still think we need a margin squeeze as part of the process to get inflation sustainably down to 2% and that probably needs a recession. It should be mild and brief but that would still take the edge off risk assets.
There are lots of speeches from Fed policy makers this week so they will have the opportunity to tell us what they think.
Until next week. Goodbye from me.
