Don’t let that headline number fool you! 315,000 jobs were added in August, but the unemployment rate rose to 3.7%. Moreover, revisions to the previous two payrolls reports (-107,000) suggest the net number of job gains is closer to 208,000. Labor force participation surged to 62.4% even as U6 climbed back to 7.0%. Wages continued to march higher with American workers earning 0.3% more per hour in August than they did in July. Where is the hiring happening? Nearly 98% of last month’s new hires came from the private sector, not bad for an economy that has undergone two consecutive quarters of negative GDP growth. We would call this a “softish report,” which also happens to be relatively benign given the tone struck by various Fed governors in August.
Last month market participants narrowed their focus to a speech from Fed Chairman Powell in Jackson Hole, WY. Importantly, this annual get together of monetary minds from around the world is NOT an actual policy setting meeting—that comes this month. Nonetheless, it is an important meeting insofar as the outlook for monetary policy is concerned. In less than nine minutes, Jay Powell roiled markets and signaled his willingness to continue his fight against inflation (not surprising). He intimated that more “pain” is ahead for consumers and businesses, leading one KPMG economist to liken the path of future hikes to “water torture” (surprising). The Fed’s weapon of choice? The US dollar. Against a backdrop of softening inflation data, this message sent shockwaves through global financial markets. Perhaps the most important takeaway from Powell’s short message was that he does not intend to reduce rates quickly after reaching the terminal level. Elsewhere, the ECB communicated its openness to a larger than expected rate hike of 75 bps. Europe has been struggling with negative rates for quite some time, so a move of this magnitude in short-term rates deserves plenty of careful consideration.
While central bankers in the developed world are brandishing their fiat currencies as weapons to combat inflationary pressures, Mr. Putin is amplifying his own pressure in European gas markets. With little diplomatic or military progress on the ground, the war in Ukraine drags on and with it the prospect of a very difficult winter season is becoming more and more likely by the day. We have said it before and we’ll say it again… until a meaningful dialogue between Putin and President Zelensky has been established, the chances for peace in eastern Europe remain very slim. Add to that some recent rhetoric from the Saudi’s along with their colleagues at OPEC+, and you have a very interesting setup for global energy markets going into yearend. More drama in the oilpatch…
Data, data, data… the latest batch confirms the domestic slowing in manufacturing and services that we have been monitoring since the beginning of summer. At the margin, this has been positive on the inflation front, but the labor market is still too hot for the Fed’s taste. Structural imbalances in Laborland augur for significantly higher rates on the frontend of the treasury curve in the near-term (EFFR is currently 2.33%). The Fed wants to cool demand by tightening financial conditions. Mr. Powell has done this quite effectively year to date, but the key to pricing pressures likely has more to do with the supply side—something the Fed has no real control over. Even though the Biden administration has done its best to distance itself from inflation and laid the problem at the feet of the Federal Reserve, economic issues that linger and fester on Capitol Hill can certainly have a type of boomerang effect. That said there have been some interesting political (ahem) developments of late. We will be keeping a close eye on the upcoming midterm elections.
From a financial perspective this toxic combination of political intransigence and zeal for ever higher short-term rates among central bankers leaves us holding onto the cash positions that we have systematically built over the course of the year (for now). We are on the lookout for attractive risk-adjusted opportunities across assets. In the equities space earnings growth is slowing a bit among S&P 500 companies, but 2022 is still shaping up to be a record year at the operating level with the end of Q3 quickly approaching. Meanwhile, real money supply in the domestic economy, as measured by M2, is coming down— those pandemic dollars are being spent, folks! Let’s also keep in mind that at this pace one would expect to reach pre-pandemic real M2 levels in roughly 2 years. This, of course, leaves US consumers with plenty of runway for the foreseeable future. What we are experiencing in financial markets is a seismic recalibration of risk in the wake of a pandemic and in the throes of a sharp inflationary cycle. During such times, volatility is the norm as markets struggle for equilibrium, but we must also be mindful that these “inefficiencies” tend to create opportunities in both liquid and illiquid assets.
Market Outlook: Neutral USD, Neutral Duration, Neutral Equities
News Release: Bureau of Labor Statistics (The Employment Situation- August 2022)