#stagflation

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The print of the monthly payroll employment number brings Wall Street cheers or anguish, filling the market airwaves with new prognostications of economic growth or stagnation. The November release was a clear example of such harrumphing.

According to the Labor Department, employment rose by just 210,000, far below the consensus of a 545,000 gain. The S&P 500 fell 1.2% and 10 bond yield fell 9 basis points to 1.33% on Friday, the lowest close for bond yields since late September. The word was the Federal Reserve may have to go slower in withdrawing their bond buying because employment is stagnating. There was some truth to the tale, however. The three-month average of monthly payroll employment gains slipped from 845,000 to 378,000, implying a labor market slowdown.

But under the hood, things appear much better, and the labor market seems to be doing just fine. First off, the unemployment rate fell from 4.6% to 4.2%. And the reason is that household employment is based on a monthly survey of the same 60,000 households which rose by 1.1 million workers. And it is the household employment measure that is used to calculate the unemployment rate, not the establishment survey that gets all the attention. Along with that increase, the labor force added 594,000 workers. That means that new entrants into the workforce were able to find jobs easily. Since unemployment is measured as a percent of the labor force, typically if employment gains are less than labor force growth, the unemployment rate rises. Not so in November.

But there is more. The labor force participation rate (the percent of the working age population looking for work and thereby in the labor force) rose to 61.8%, climbing out of the range it had been in since mid-2020. This is important because it shows that workers that have laid back looking for work for various reasons like federal and state unemployment assistance, are now willing and able to be employed.

While the markets viewed the November report as a sign of slackening in employment, more robust measures suggest otherwise. Along with the labor force participation rate, weekly initial claims for unemployment insurance have declined sharply over the past two months, from 364000 to 222,000, a 39% reduction, bolstering the message of continuing momentum on the job front.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

September marked a much weaker month for financial markets. Here are 3 things you need to know:

1. Inflation moderated across a few major categories that have been the most impacted by supply chain shortages and pent-up consumer demand, such as used cars, airlines and hotels. However, energy prices surged during the month with WTI oil increasing +9.5% for the month.
2. Expiring extended federal unemployment benefits did not bring a surge of job growth as expected. Robust wage growth suggests the weakness is primarily supply-side driven.
3. Signs of slowing growth and higher inflation brought up talk about stagflation. Arguments for a reflationary environment in 2022 in the U.S. include a healthy consumer and still-supportive monetary policy.

Sources:

1. Sources: J.P. Morgan Asset Management – Economic Update; Bureau of Economic Analysis (www.bea.gov); Bureau of Labor Statistics (www.bls.gov); Federal Open Market Committee (www.federalreserve.gov)
2. Indices:
   • The Barclays Aggregate Bond Index is a broad-based index used as a proxy for the U.S. bond market. Total return quoted.
   • The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
   • The MSCI ACWI ex-US Index captures large and mid-cap representation across 22 of 23 developed market countries (excluding the U.S.) and 27 emerging market countries.  The index covers approximately 85% of the global equity opportunity set outside the U.S. Price return quoted.
   • The MSCI Emerging Markets Index captures large and mid-cap segments in 26 emerging markets. Price return quoted (USD).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The Federal Reserve’s latest policy meeting last week finally put some meat on the bone by concluding they would start the tapering of their $120 billion monthly purchases of government securities. Though they were inexact as to the precise timing, it appears the program will begin in November and finish up by mid-2022.

But there were a couple of things in the Fed’s statement that took the market by surprise. The Fed issues a detailed quarterly summary of what members of the Federal Open Market Committee (FOMC) individually forecast about the next 3-year movements in inflation, economic growth, and the Federal funds rate. Those estimates are summarized in a Summary of Economic Projections (“dot plot”) where each of the 18 members (including Chairman Jerome Powell) map their projections on a three-year ahead calendar. It’s there where the changes since the June summary had market impact.

In their last “dot plot” in June, seven of the 18 members thought that the Fed should start raising interest rates by the end of next year, rather than in 2023. In the latest one, half of the committee determined that 2022 was more likely (when the tapering was finished). They also pushed their longer-term interest rate estimates higher. One reason appears to be that during the interval between June and September, annual inflation (CPI basis) rose to 5% as supply bottlenecks and rising wages continued to increase business and consumer costs. Elevated risks to their estimate of “transitory” inflation appear to have prompted Fed officials to begin their tapering and to revise their interest rate timing and to increase their interest rate projections. Market watchers dubbed this as a hawkish turn in Fed policy.

At the same time, however, employment gains slowed and high frequency economic data on retail sales and manufacturing and service activity weakened.  The specter of stagflation has begun creeping into economist’s lexicon, a legacy of the 1970’s. In previous meetings the Fed had emphasized that “substantial further progress” on employment would be needed for them to move to raise interest rates. In this meeting, the Chairman stated he is looking for “accumulating progress”, appearing to back off from his earlier statement.  With eight million people still unemployed and the slowing in employment gains, the Fed’s message seems to be that inflation is now a more pressing policy issue, especially if the gargantuan $3.5 Trillion spending bill is passed.

So, what has the market impact of all this been? Bond yields declined initially as some investors believed that the start of a less accommodative policy and a possible rise in interest rates in 2022 would forestall more rapid increases required later to confront inflation. But that sentiment didn’t last long. The Fed’s preparing to end its ultra-easy monetary policy has also signaled that the economy would continue to strengthen in the short term, putting upward pressure on interest rates, a view that shortly began to dominate bond market sentiment. Bond yields quickly turned higher. In fact, they have touched multi-month highs. And it didn’t help that several European Central Banks have either ended their bond purchase program (QE) or have begun raising rates.

Stocks were a different story. They reacted bullishly and interpreted the Fed moves as affirmation that the economy was on a solid growth path, giving confidence to expectations of healthy gains in corporate earnings. In fact, the S&P 500 registered its largest 2-day gain since mid-July at 2.2%. Small cap stocks (Russell 2000) rose 4.2% and banks have surged by 6 1/4%, indicative of investor confidence in the ongoing cyclical upswing. The long-term equity uptrend continues despite a changing Fed policy and an eventual rise in interest rates.

1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
2. The Russell 2000 Index is a small-cap stock market index of the smallest 2,000 stocks in the Russell 3000 Index.

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