05 Mar FEBRUARY’S EMPLOYMENT REPORT AND FRB CHAIR POWELL
Today the pivotal February employment report is released. In my view perhaps the most significant aspect of this very inclusive release is the average hourly earnings data.
January’s wages increased at a 5.4% annual rate, which is around the same rate expected for February.
Wages are increasing about two times the rate of inflation which in itself is macroeconomically positive as purchasing power is dramatically rising, hence increasing demand pull inflation.
Regarding cost push inflation (wages), at some juncture rising wage will become inflationary as labor is the largest cost of production. At what juncture will producers pass these increased labor costs onto the consumer? Just as significant what happens if these costs cannot be passed onto the consumer, hence hurting profit margins?
As widely discussed, according to the CBO the majority of people on extended unemployment benefits contained in the various COVID stimulus programs pay people more not to work rather than too work. I will skip the moralizing and only comment about the possible macroeconomic implications. If cost push inflation develops, partially the result of government/fiscal policy, the odds of a negative feedback loop increases significantly.
The last time the economy experienced both cost push and demand-pull inflation was in the late 1970s. As noted last week, the two-year Treasury yielded an all time high of 16.25% in August 1980. Today it is around 0.125%. The two-year Treasury is the instrument most sensitive to monetary policy. There is no room for error in monetary policy.
Speaking of which, yesterday FRB Chair Powell stated “the recent spike in Treasury yields has caught his attention.” The Chair reiterated well known talking points that it intends to continue with planned asset purchases and will give the market ample warning as to when purchases will begin to decline. He also reiterated the Committee’s intents to keep the overnight rate at current levels to end of 2023.
The markets were initially unmoved by his comments but were spooked when the Fed chief stated it will tolerate “a higher rate of inflation but such an increase will only be transitionary.” Immediately following this statement, yields spiked to intraday highs and mega sized equities began to swoon. Fed funds futures—which is a measure of market sentiment–radically changed its expectations of the first-rate hike to early 2023 as compared to late 2023.
While the above statement is not new, what is new is inflationary expectations are at a 13-year high but the Fed has no intent to change policy to combat inflation. The primary determinate of bond yields is inflationary expectations and the Fed is attempting to do something no other central bank has successfully achieved…let inflation run higher than the proverbial speed limit and then gently reducing these pressures.
Speaking of potential inflationary pressures, oil surged over 5% yesterday as OPEC announced its intentions to keep production at current levels. A combination of the Administration’s oil policy, reduced capital expenditures by all involved in the oil industry, amplified by stronger than expected growth, Goldman is now suggesting oil will be in the “mid 70’s” by summer driving season.
As indicated earlier, primarily because of the rise in rates, equities led by the NASDAQ traded lower. The NASDAQ at one time was “correction territory” defined as a decline of 10% or more. The only sectors showing gains were energy and utilities.
What will happen today?
Last night the foreign markets were down. London was up 0.32%, Paris down 0.35% and Frankfurt down 0.62%. China was down 0.04%, Japan down 0.23% and Hang Seng down 0.47%.
The Dow should open flat, NASDAQ down about 0.5% but this could change radically given the significance of the 8:30 labor data. The 10-year is unchanged at a 1.56% yield and oil is up another 2.5% to over $65.50/barrel.