My, my, my… another strong print for the labor market. BLS reported this morning that American payrolls expanded by 263,000 in the second to last month of 2022. On the private side of the ledger leisure and hospitality lead the way with new hires totaling 88,000. Meanwhile, government hiring activity totaled 42,000. These two components made up nearly half of the new jobs in November! I suppose DoorDash and weekend trips are becoming household essentials in this brave new world. Back to the report, the official unemployment rate held steady at 3.7% as U6 ticked down slightly to 6.7%. Part of the trouble with these figures is that the labor force is not expanding the way that we would like to see at this stage of the economic cycle. In fact, labor force participation lost 0.1% last month despite the strong headline jobs number, and there are still ~1.7 jobs (October JOLT’s) available for each unemployed American. Clearly, imbalances persist, and the effective fed funds rate is 375 bps (3.75%) higher than it was in March. Plenty of wood to chop in Laborland!
The story of 2022 is largely a story of currency—particularly the US dollar. Without question the strength of the dollar has been felt the world over. In prior notes we highlighted some of the issues that the UK and Japan have encountered lately in currency markets, but let’s not forget that the greenback is still the world’s reserve currency—its influence is global AND it has scale. The strength or weakness of any developed market currency is largely underpinned by interest rate differentials—these days that is primarily a function of the divergence or convergence of monetary policy among central bankers. The impact of the federal funds rate (established by the Federal Reserve) and movements in short-term US treasuries cannot be overstated, especially in today’s marketplace. The reason is simple: the collective impact of these financial forces affects the pricing of virtually everything (i.e. goods and services), everywhere. These “impact points” can be either direct or indirect. After all, currencies are the largest, most liquid, and most important markets in the financial universe. 2022 has certainly been a stark reminder of that simple truth. Statements like turning “the ruble to rubble” emanating from Pennsylvania Avenue or “cash is king” reverberating along Main Street underscore a basic and essential fact: currencies matter.
For its part, the Federal Reserve does not like to explicitly address the strength or weakness of the dollar. Mr. Powell is careful to frame his commentary through the lens of the Fed’s dual mandate from Congress: price stability and maximum employment. Of course, these are relative terms in and of themselves. For instance, the strength of the dollar has an outsized impact on domestic manufacturing. For goods of similar quality and durability, the strength of the dollar effectively reduces the competitiveness of any dollar-denominated product in the international marketplace (last month’s US ISM manufacturing index contracted for the first time since May 2020). Though Powell and company are quick to point out that their tools are designed to impact demand, which they undoubtedly have, the year to date result on the global stage has been more scarcity of product. This is certainly not a desirable outcome in a world still struggling with supply-side constraints. Moreover, labor productivity on the domestic front has also been a trouble spot economically along with stubbornly low labor force participation—both of which are inherently inflationary. In sum the Fed has encountered an unprecedented challenge in restoring equilibrium to the domestic economy with little if any assistance from Capitol Hill. However, a glimmer of hope maybe emerging as the contours of the global economic landscape appear to be changing (at least a little bit)… and that is a big relief for Mr. Powell.
Most recently China’s response to Covid related protests are an encouraging sign. Though cases are spiking and the death toll is rising on the mainland, Chinese authorities have adopted a more “patient” stance. The departure from “dynamic Covid Zero” will be a process—it will not happen overnight. Meanwhile, Xi Jinping will not want to appear as though he is bowing to the will of the people. A more realistic posture with respect to Covid-19 appears to be somewhere on the horizon. In the US a divided Congress likely reduces the probability of a fiscal error. Please note reduce does NOT mean eliminate. Though it will be difficult for democrats to legislate with the House of Representatives in republican hands, the November elections hardly resulted in a sea change in the halls of Congress. President Biden has been seemingly emboldened by the results, and his economic agenda remains intact though there have been rumblings about key staff changes within his administration. Meanwhile, November data suggest inflationary pressures in Europe AND the United States are diminishing, which has opened the door for a smaller rate hike (50 bps) at the December FOMC meeting. One month is hardly anything to write home about, but a uniform slowdown in the developed world is certainly a positive sign at this stage of the rate cycle. Perhaps the most important takeaway from last month’s economic data is that it reduces (AGAIN, reduce ≠ eliminate) the risk of overtightening. This is not to say that we are out of the woods with respect to policy errors, but in a year fraught with risks of all kinds we are certainly glad to see it! Let’s hope our policymakers can build off of the good news.
As we close out what has been another “eventful” (polite term) year, our view across assets is much the same as it was at the end of the summer: as we approach the terminal rate in fed funds, patience will be rewarded as opportunities become more apparent in both liquid and illiquid assets. To be sure, this does not mean that it is wise to throw caution to the wind as valuations remain in flux! The mistakes that were made that got us into this global pickle were monumental in magnitude. It will take time to find equilibrium, restore confidence, and right the ship. Historically, that has been a strong setup for opportunities. Thus, TWP’s fair value estimate remains unchanged at 4200 for the S&P 500 with earnings growth likely settling in the mid-single digits for the year. We will back in 2023 with more facts, figures, and estimates, and we will also be bringing you our first look at markets in the New Year. With that we wish you happy holidays from all of us at TWP!
Market Outlook: Neutral USD, Neutral Duration, Neutral Equities
News Release: Bureau of Labor Statistics (The Employment Situation- November 2022)