The Reality that Lurks Beneath the Surface
The September jobs report disappointed with a mere 194,000 new payroll jobs, a totally misleading sense of how the labor market is performing. Everything else in the report was consistent with the ongoing solid recovery of the labor market. So, we expect the Federal Reserve to announce the start of its tapering of bond purchases in November, as Powel previously hinted. Most importantly, the employment report suggests that the surge in inflation may not be as transitory as hoped.
Consider all of the following: the unemployment rate plunged to 4.8% (5.1% was expected); average wage rates rose 0.6% (0.4% was expected); the workweek jumped 0.2 hours (flat was expected); initial unemployment claims dropped sharply to 326,000; the household survey showed 526,000 new jobs; job openings are at record levels above 10 million; ADP reported 568,000 new jobs in September (more than expected); but payroll employment came in at 194,000, well under the 479,000 that was expected, with a sizable decline in education jobs, public and private, of 180,000. One of these doesn’t fit with any of the others and it is the payroll report. Hiring in education exceeded 1 million people, but the seasonal factors expected even more, so the large decline reflected the difference between actual hiring and what was built in by the seasonal factors. The rest of the economy did fine by every measure available.
So, what do we conclude? Growth did slow a bit over the summer, with the rise in Covid cases inducing some caution and disrupting activity because of the bottlenecks it created. But growth was still quite solid, despite these headwinds. Now with Covid receding and the economy continuing to open up, growth will soon pick up some tailwinds. People are slowly but surely reverting to more normal behavior, even as they remain careful about Covid. That’s very positive for economic growth. And if some version of Biden’s infrastructure and Build Back Better social programs ultimately get approved, which seems likely, the tailwinds may become turbocharged, even as labor scarcity is already driving up labor costs. That’s a clear prescription for more upward pressure on inflation that could overwhelm whatever elements of our high inflation rate that might wane due to their transitory nature. The Fed’s 2% inflation target looks increasingly less attainable for the visible future.
The bond market oscillated quite sharply both up and down in the aftermath of the employment report as investors tried to discern its underlying message. It took a few hours, but yields rose by lunchtime and remained higher, which in our judgment, was the correct reaction. The risk of inflation exceeding the Fed’s target is a significant one, even as the Fed has not yet begun to moderate its emergency bond buying program in the slightest, as yet. That’s coming. It won’t begin until later this year (and we’re quickly running out of time) and all the bond buying should be done by the middle of next year. So, the Fed is moving slowly and very cautiously, but in doing so, they risk allowing these inflation pressures to become embedded in the economy. A return to the high inflation rates of the 1970s is still very unlikely. We remain a long way from that kind of outcome. But inflation is likely to remain well above the Fed’s 2% objective for some time to come.
The implications for investments decisions are quite clear and straightforward. We remain extremely defensive in our bond positioning, preferring to minimize our interest rate risk and accepting some credit risk instead to maintain yields in our fixed income exposure. With regard to stocks, we remain focused on companies that will benefit as the economy reopens and also benefit from rising inflation.
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