“There simply isn’t the conviction or willingness to take your underlying core exposure back up in meaningful fashion ahead of months of economic data volatility,” Nomura’s Charlie McElligott said Tuesday.
Given the lack of visibility on the macro front, policymakers are constrained in their capacity to employ forward guidance. The best they can do is speculate on the likely outcome of the next meeting or two. Beyond that, they have to preserve as much optionality as possible. They’re in “reactive” mode.
That setup is conducive to “illiquid and volatile trading,” McElligott wrote, and it’ll likely last at least through the summer months.
The Fed is looking for slower inflation, yes, but also signs that the labor market is cooling. There’s a sense in which JOLTS and NFIB are now just as important as NFP. That’s only a slight exaggeration. Job openings and hiring intentions absolutely have to normalize before the Fed can even think about dialing back rate hikes.
This will be the “summer of Volcker,” BofA’s Michael Hartnett declared. Strictly speaking, that isn’t especially likely. The odds of a Volcker cameo diminished materially in December of 2019.
But Volcker will be with us in spirit, guiding policymakers in their quest to save the economy by kneecapping it. “Central banks are just getting started, terminal rates are trending higher across the G7 [and] there’s no fun ’til the Fed’s done,” Hartnett quipped.
The figure on the left (above) is another way of visualizing the disconnect the Fed is attempting to address.
Speaking of summer and Volcker, Larry Summers, along with two fellow economists, published a paper this month based on reconstructed CPI series aimed at facilitating apples-to-apples comparisons across time. “Using these series, we find that current inflation levels are much closer to past inflation peaks than the official series would suggest,” Summers wrote. The implication: Powell does in fact need to “pull a Volcker,” as it were. “To return to 2% core CPI inflation today will thus require nearly the same amount of disinflation as achieved under Chairman Volcker,” the paper concluded.
The Fed may not actually be required to do all the heavy lifting, though. Seemingly every day, investors wake up to more reports of hiring freezes, job cuts or guidedowns. Target on Tuesday blindsided investors with another profit warning, reports indicate Microsoft is poised to slow hiring “significantly” and, as Goldman wrote, “Walmart and Amazon, recently said strong demand growth and worker absenteeism led them to overestimate their hiring needs.” Even crypto is downsizing, which speaks both to the macro environment and the diminishing wealth effect as speculative assets wilt under the heat of rate hikes and suddenly positive real yields.
“If more companies draw the same conclusion, openings could normalize part way on their own [meaning] a more limited growth slowdown would suffice to reduce total labor demand enough to bring the labor market back into balance,” Goldman’s Joseph Briggs David Mericle said.
For BofA’s Hartnett, this is pretty straightforward, as most things are according to his famous shorthand. We need a “negative payrolls print,” he said. We probably need a few of them, actually, alongside a string of cooler inflation readings or definitive evidence of an economic downshift.
“Perhaps three consecutive months of inflation data moving sustainably lower or, conversely, maybe it’s an FCI tightening that sees PMIs push back into contraction territory,” Nomura’s McElligott remarked. He continued: “Or multiple ‘negative’ NFP prints in a row which, in a different manner, [sends] the same dovish signal to markets [albeit] with a more ominous ‘cycle’ message.”
A lot hangs on the mismatch between workers and open jobs. Goldman flagged a shift in the Beveridge curve (figure below), which Briggs and Mericle speculated is attributable to “geographic mismatch, employer-employee disagreement about remote work and reduced job search intensity by workers who had COVID concerns or a financial cushion.”
The bank doesn’t expect a shift back to pre-pandemic levels, but any little bit would help. Any increase in match efficiency would reduce job openings, thereby lowering the odds of a downturn driven by a sizable jump in the unemployment rate.
As with everything else in the post-pandemic economy, that discussion admits of so much ambiguity as to render it scarcely worth having.
“If the curve were to fully shift back — a possibility that Governor Waller raised in a recent speech — then little to no increase in the unemployment rate would be needed,” Briggs and Mericle said. “But if it does not shift at all, then reducing labor demand would require a larger increase in the unemployment rate, which would more likely entail a recession.”
More frequently than was occurring pre-covid, when I eat out – first, I download the menu from a QR code, then I place my order thru the interface on my phone. After I finish eating, my bill is sent to my phone and I settle up with apple pay. I like this because after I finish eating, I don’t have to spend, what sometimes seems like forever, trying to get the waiter’s attention to bring me my bill, then wait again to complete the payment process with a credit card.
Slightly different process depending on which software the restaurant uses, however, the technology means less front of the house/wait staff required. This trend is here to stay.
On a similar note, I rarely use a human cashier at the grocery store anymore, either. I have gotten proficient at using automated checkout- even when buying lots of fruits and vegetables- so generally a faster check out experience and I don’t want the cashier to touch the food I am buying. I see that more automated check out stations continue to be added in retail stores.
Companies are going to continue to shift the order and payment processes to the customer, in order to reduce the number of unskilled employees required. Given technology and time, the current worker shortage problem will be substantially reduced.
Here is an opposite experience. One of the local restaurants/bars has switched to cash/check only to try and lower the effect of inflation. So far it doesn’t seem to have effected business.
Simplistically, it seems to me there are inflationary pressures from the domestic economy (high demand, labor shortage, etc) and there are inflationary pressures from external sources (energy, food, China disruptions). If the external sources do not relent, how much FCI change will it take to reduce the domestic sources enough to bring overall inflation down enough for the Fed to ease off its tightening? I’d sure like to understand that.
Again, the money to support all this excess demand has to come from somewhere. COVID relief seems to have been nearly entirely spent by now and real wages are generally down/trading water at best.
Seems to me like the drop in demand could be quite sudden.
Lots of people, very much me included, thought we (royal we, the US gvt) could do a second big relief package in 2021 b/c the relief package of 2020 hadn’t generated inflation. That was a mistake. Apparently people saved their 2020 fiscal gift but decided in 2021 to go berserk, spending both the 2020 and 2021 amounts all in one go.
I don’t get how these consumers think (I mean, I get it, but it implies adults have the financial reasoning abilities of a 5 yrs old) but, now that’s gone, the demand drop could be quite steep.
FWIW (maybe 2 cents), here my roadmap.
Over the summer, I think we’ll see spreading weakness in sales of large ticket goods, hiring freezes and layoffs, stalling and declining house prices, margin contraction, misses, guidedowns, and estimate cuts.
I don’t think the slowdown will be enough to forestall 50 bp in June and 50 bp in July. Short rates will keep going up. Long rates might be pressured down by the slowing economy, but might be lifted by QT, so who knows. Curve flattening or renewed inversion is possible.
It will look like the start of the recession that economists and strategists have predicted for 2023. My bet is and has been that the recession will start in 2022.
If this all drives inflation down sharply, and the market thinks the Fed will start winding down its tightening by fall, then we could have a 4Q rally. It isn’t atypical for the market to bottom not too long after a recession starts, if Fed support is expected.
If war, oil, grain, drought, and Heaven forbid another wave of China lockdowns keep inflation stubbornly high despite this economic slowdown, such that the Fed might have to keep tightening aggressively into a recession, then the outlook is a lot worse.
Insight into the different contributors to inflation will be very useful. We should all be studying the market baskets used for CPI and PPI. Also watch the war closely. At some point, one or both sides will be exhausted. It doesn’t feel like they are close to there yet.
What to do. I am prepared for a market that is volatile, choppy, and ultimately goes nowhere over the next couple months. Pulling exposure even closer to neutral, looking to reduce outsized bets and take profits, screening for and adding quality names that have descended to something approaching washed out valuations. Which might describe some categories of fixed income. Trying to go into fall with as much dry powder as is reasonable. 50% of portfolios in cash, cash-like, and liquid hiding places that can be quickly converted to cash, does not seem unreasonable.
The CPI market basket is 13% food (at home 8%, away from home 5%), 7% energy (gas+diesel 4%, electricity 3%), 7% rent, 24% “owners’ equivalent rent”, 7% medical care services, etc.
Household furnishings and appliances is 4%, apparel 2%,”recreation commodities” (consumer electronics, sporting goods, pet supplies, toys, etc) 2%. So widespread discounting of TVs, furniture, and stationary bikes can move the needle, but not control it.
Of course, “core CPI” excludes food and energy, but the Fed is presumably not unaware of 20% of the market basket.
If someone has looked at PPI composition, I’d be interested.
Thanks jyl for sharing your roadmap!