Macro Riddle Has Just One Solution

The recent rally in equities in part reflects the market front-running an eventual negative payrolls print.

That’s according to BofA’s Michael Hartnett. He wasn’t, of course, referring to November payrolls, but rather just the generalized narrative that says the first negative NFP print marks “the pivot is here” moment for the Fed.

It’s a familiar narrative. The Fed wants to cool the labor market to corral wage growth, which is still running far too hot to be consistent with 2% inflation. Officials’ projections for the jobless rate are still unrealistically low, according to many critics, but Jerome Powell continues to lean on the notion that the Fed can avert mass job losses by squeezing out superfluous vacancies. This week’s JOLTS report suggested incremental progress on that front — at best.

“Bulls need wage growth to decline sharply without big job losses,” Hartnett said, in the latest installment of his weekly “Flow Show” series, released on the eve of November payrolls. The figure (below) gives you a sense of where annual wage growth is headed based on various assumptions about the MoM prints.

If you want real wages to grow, and you don’t think annual, headline inflation is likely to see a three-handle in the very near-term, you need nominal wage growth of at least 0.3% MoM. But that’s an exercise in question-begging: 0.4% MoM prints get you 5% 12-month wage growth, but I’m not sure that’s consistent with 2% inflation.

In any case, BofA says it’s up to the US labor market to “resolve the narrative” — as the curtain closes on 2022, the macro is just one big enigma. The evolution of monthly payrolls in the world’s largest economy are the key to solving the riddle.

For bears (and Hartnett still counts himself in the bearish camp), the concern is that “unemployment in 2023 will be as shocking to Main Street consumer sentiment as inflation was in 2022.” That’s particularly true given the rock-bottom savings rate (figure below).

The standard copy that accompanies that chart reads as follows. Americans are running down their cash buffers amid the highest inflation in a generation, and the burn rate could be particularly high among upper-middle-class spenders keen to preserve their lifestyles.

Revolving credit is on the rise too, suggesting Americans are increasingly predisposed to plasticizing monthly budget shortfalls, a potentially perilous bent considering soaring card rates.

Read more: Americans Have Some Credit Card Debt

“Households continue to mine a mountain of extra funds piled up during the pandemic,” BMO’s Sal Guatieri said this week. “This extra piggy bank could last another year, underpinning consumption.”

The bottom 20% of households by income don’t have an “extra piggy bank,” by the way. But higher up the income ladder, the combined cash cushion versus pre-pandemic levels summed to more than $3.5 trillion as of late June. It’s probably lower now.

BofA’s Hartnett suggested the combination of rising unemployment in 2023 and a near-record low savings rate could make for a pernicious conjuncture.

“With consensus of ‘soft’ recession and lower, but still high-ish inflation, the ‘tails’ for 2023 are an outright hard landing and deflation or the return of ‘Goldilocks,'” he wrote. “Ultimately, the labor market [will] resolve the narrative. “[We’re] selling risk rallies from here as the market [is] too aggressively front-running a negative ‘the pivot is here’ payroll.”