November 3, 2023
According to the Bureau of Labor Statistics, American employers added 150,000 jobs in the month of October. Last month’s figures from ADP (113,000) seem to corroborate newfound slack in the US labor market to kick off Q4. Meanwhile, the official unemployment rate held below 4% at 3.9%, but U6, a broader measure of unemployment, jumped to 7.2% last month. Softness in hiring activity among private companies (99,000) was somewhat offset by an increase in government payrolls (51,000). Wage gains totaled 0.2% MoM, which tracks well with our Q3 dataset (more on that below). Not only did the US economy prove resilient during the summer months, GDP actually surged at an annualized pace of 4.9%! Moreover, this level of economic activity was buttressed by a winning combination of declining labor costs (-0.8%) and a dramatic increase in productivity. To be sure, the picture we are painting of the domestic economy isn’t all roses, BUT it isn’t altogether bad. Indeed, there appears to be something for everyone (good or bad) under the current circumstances, though it certainly isn’t “one size fits all” either. This is the nature of rebalancing, adaptation, and above all… transition.
At this stage, financial stability ought to be feeding into the Fed’s cumulative calculus. Prior to Mr. Powell’s Wednesday address, 10-yr US treasuries had ticked higher by a staggering 63 bps since Jackson Hole. Moreover, rate volatility across the curve has exploded in recent days/ weeks. We would also note here that real rates on 10-yr treasuries had also increased by ~54 bps since late August. This means that domestic financial conditions have been meaningfully tightening in the absence of incremental inflationary pressures (AND Fed action). Of course, some of the movement in rates can be attributed to hostilities in the Middle East and stronger than expected US economic data post- Jackson Hole. However, we would be remiss if we did not mention that there is also a significant component of debt market instability that can be explained by fiscal policy (i.e. government spending), increased debt issuance by the Treasury (i.e. funding said spending), and balance sheet runoff at the Federal Reserve (i.e. draining liquidity from one of the most important markets in the world). Obviously, some of this can be controlled and some of it cannot. To the extent that some of these destabilizing forces can be mitigated, the better off markets (broadly speaking) and assets (generally speaking) will be. The wheels on the financial stability wagon have been looking a bit wobbly lately.
A suggestion we have discussed off and on over the past 12 months or so is the possibility of a “twist” from the Federal Reserve as real rates rise to restrictive levels. For those unfamiliar with monetary policy and various central banking strategies, a twist is a balance sheet management approach which effectively allows a central bank to change the composition/ duration of its portfolio without increasing the amount of its holdings. As securities mature, the proceeds are invested in longer dated assets further out on the curve. This sort of action features two important benefits: first, it provides depth to a wide range of securities that have a greater sensitivity to changes in interest rates—this “sensitivity” is commonly referred to as duration, AND it is perhaps the most relevant risk in financial markets today. Secondly, it positions the Fed in a much more proactive stance with regard to rate levels in the US. This would certainly help confidence in the marketplace for various risk assets. Rather than operating from a protracted reactive/ defensive position with regard to global events and/ or domestic economic developments, Mr. Powell would place himself in the driver’s seat (as opposed to the backseat). The Fed would have more flexibility to combat near-term inflationary flare ups with short-term rates, while preserving the future value of long-term investments (one of the pillars of capitalism). For anyone tired of watching the tail wag the dog at FOMC meetings this would be a momentous development and likely prove a turning point for financial assets.
Of course, a twist is commonly viewed as “stimulative” and why would anyone need to stimulate the US economy? After all, we just had a 4.9% Q3 GDP print! This begs the question: is the domestic economy “strong” or is it perhaps more appropriate to say that it is “out of sync?” A twist at this juncture would require a nuanced approach from the Federal Reserve and a bit more candor regarding the magnitude of policy missteps over the past few years. This would certainly shake things up. We won’t hold our breath for that, but a nuanced approach to monetary policy in the current environment is certainly worth a thought.
News Release: Bureau of Labor Statistics (The Employment Situation- October 2023)