It was a light week for economic data, giving markets time to digest and analyze the prior week’s Fed meeting and the unexpected jobs numbers. By Friday (February 10), with the Fed’s unanimous FOMC view that the future held interest rate increases (plural) and reinforced by the spectacular +517,000 jobs numbers, the markets threw in the towel on their bet that a rate “pause” and subsequent “pivot” to lower rates would occur sooner rather than later, and have resigned themselves to at least two more rate hikes in 2023’s first half. Note the recent upward spikes shown in the chart above for the 10-Yr. and 2-Yr. Treasury Notes indicating such capitulation.
The Fed’s Dilemma
For the past several weeks, we have discussed the Fed’s “dilemma,” which arose out of its newly found “transparency” with regard to its interest rate intentions. The “dilemma” revolves around market perceptions of the Fed’s rate intentions. In the initial stages of the current tightening regime, markets rapidly moved rates up to what the Fed communicated were their rate intentions. The Fed was fine with this. However, as the time has approached for the Fed to “step down” its rate increases, perhaps “pause” or even “pivot,” markets have moved rates down. This caused angst among Federal Open Market Committee (FOMC) members, now worried that markets have discounted the Committee’s resolve. The following is from the December minutes:
Participants noted that because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.
A look at the chats of the two Treasury Notes (above) reveals that rates peaked in November and, until this past week (ended February 10), had been on a significant downtrend. That appears to have been broken, and, at least for now, the financial markets appear to have become more “attuned” to the Fed’s view of interest rates. As discussed later in this blog, this new market view may change depending on the news from next Tuesday’s (February 14) Consumer Price Index (CPI) report. The chart below shows the current market view of the Fed Funds rate through the end of 2024.
Note that markets now see two rate hikes (the gold bars in the chart), accepting the plural “increases” from the Fed’s February 1st FOMC statement. Those hikes occur at the next two meetings (March and May), followed by a “pause,” with rate cuts beginning in Q4/2023. This is a change from the prior market sentiment, which saw an earlier “pause” and “pivot” in Q3. Nevertheless, it is still a Recessionary view.
It isn’t hard to pinpoint why market sentiment changed, i.e., the apparent unexpected large jump in the jobs report last week. Whether or not the +517,000 jump in payrolls is accurate or sustainable, if market participants believe that the Fed is influenced by, and will act on such data, then there is no sense in fighting it (i.e., the old adage – “don’t fight the Fed”).
Implications of Higher for Longer
Because markets now believe that interest rates will remain higher and for longer than recently anticipated, the implications for the length and depth of the Recession have also changed. And that includes the equity market. Equity markets, for the most part, have been on a tear all year (2023) until this past week (February 10). The change given future Fed actions not only changed attitudes about interest rates but also about corporate profits and, thus, equity prices. Note from the table that this past week (February 10) was the first down week of the year for the Nasdaq and the first down week for all three major indexes.
Consumer Price Index
The key report next week will be the Consumer Price Index (CPI). It will be released on Tuesday, February 14, and, depending on January’s inflation rate, may reignite the market’s move toward lower rates. Over the past three and six-month periods, the annualized rate of inflation has been less than the Fed’s 2% target. It appears that the Fed has been (and still is) looking at the “headline” rate of inflation, i.e., the year-over-year rate, which, through January, had risen 6.4%. We did a thought experiment asking what the year-over-year rate of inflation would look like if, over the next six months, the CPI continues to behave as it has over the past three-month period.
The chart is nearly identical if the CPI inflation rate over the past six months is used instead of the 3-month inflation rate. By June, the year-over-year rate is below the Fed’s 2% target. The question is, will that be enough for them to “pivot?”
Payroll Data and the Labor Market
As we indicated in our last blog, given sluggish economic indicators from nearly all the economic sectors, the Payroll Survey’s +517,000 Seasonally Adjust number seemed like an anomaly. We expect seasonal layoffs in January after the holiday season, and when we looked at the Not Seasonally Adjusted number, we found it was -2,505,000. It seemed like a large number; how could it turn into +517,000 on a Seasonally Adjusted basis? So we examined the BLS’s Payroll data for the December-January periods from 2016 through 2022. For those seven years, the raw, Not Seasonally Adjusted data averaged -2,919,000, resulting in an average +232,000 Seasonally Adjusted change. Since, at -2,505,000, the January 2023 Payroll Survey’s raw data was less than that average, a higher Seasonally Adjusted figure should be expected. Of course, that’s the +517,000 number.
Given the sluggish data in the basic economic sectors (don’t forget, Q1/22 and Q2/22 both had negative GDP growth, and deceleration was evident throughout November and December), one must wonder why the Not Seasonally Adjusted data was better than the average of the last seven years? Our view is that many businesses have been reluctant to cut staff given the issues surrounding what COVID did to the labor market and the resulting difficulty in finding employees over the past couple of years. But now we note that the labor market is loosening up, as seen in this WSJ article. https://www.wsj.com/articles/jobs-hiring-boom-layoffs-employment-11675947399
Why, suddenly, is labor easier to find? That’s an important issue regarding one’s view of ongoing economic growth.
In addition, the quality of jobs is also an important variable in assessing the health of the labor market. The right-hand side of the chart shows that part-time jobs (black line) have rapidly increased, while full-time job growth has been essentially non-existent throughout the second half of 2022. While jobs may have grown, their quality likely can’t sustain an economic expansion.
Layoffs have now become a daily announcement – that is, major company layoffs. The WSJ published a list of recent corporate layoffs. These include Google, Amazon, Dell, Disney, IBM, Microsoft, Salesforce, Zoom, Blackrock, BNYMellon, Goldman Sachs, Fed Ex, McDonald’s, Coinbase, Boeing, Dow, and MMM … (the list goes on). https://www.wsj.com/articles/the-companies-conducting-layoffs-in-2023-heres-the-list-11673288386
We added up the number of layoffs at the 32 companies that made the WSJ list. That number was more than +93,000 (some companies didn’t specify a number). In past blogs, we noted that the layoffs were concentrated in the tech sector, and we commented that we were worried because the tech sector has been America’s growth engine. But now, the layoffs have spread to financial services, retail, crypto, and even entertainment sectors (Disney). The latest weekly data from the Department of Labor (week of January 21) shows large weekly changes (more than +50,000) in Continuing Claims (those on unemployment benefits for more than a week). As a result, even though the unemployment rate (U3) fell to 3.4% in January, the U6 unemployment rate (which has a broader definition than U3 and includes “part-time for economic reasons” and those that aren’t in the market for a job but would take one if offered) rose from 6.5% in December to 6.6% in January. We expect to see the unemployment rate move up as 2023 unfolds.
There is no doubt that the U.S. economy runs on credit. In December, the height of the holiday spending season, consumer credit advanced at a +2.9% annual rate, the slowest growth rate since November 2020. It should also be of concern when America’s banks see falling loan demand and, at the same time, are tightening credit standards.
The left-hand side of the chart below shows a falloff in every loan category in Q4/22. The right-hand side shows the move toward tighter lending standards at America’s banks.
We have commented in past blogs about the rapid runup in credit card balances as consumers attempted to maintain their living standards. Discover, Inc. now expects its charge-off rate to rise to 3.9% in 2023, up from 1.8% last year. In our last blog, we also commented on rapidly rising auto delinquencies. So, it’s not a wonder that lending standards are tightening. Our last comment on this file is: Without credit availability, economic growth is hard to come by.
Housing starts, and permits are down. Months’ supply of inventory is rising. Prices of both new and existing homes have begun to fall. At the heart of the matter here is something called Housing Affordability. The chart shows that affordability is now lower than it was at the height of the great housing crisis during the Great Recession.
It now takes an annual income of nearly $100,000 to afford a median-priced home. That’s up from $55,000 just two years ago. Something will have to give (either interest rates have to fall, or prices must come down – likely both!). It is noteworthy that prices in Canada have already fallen -19% from their peak in early 2022. Without a healthy housing sector, it is hard to see a vibrant economy.
Based on a lot of jawboning and a much better-than-expected jobs report than what was priced in, financial markets moved rates up substantially this past week, now apparently seeing a higher probability of a “soft landing” and, perhaps, the need, as expressed by the Fed, for still higher interest rates.
The first test for the markets’ new view may occur as early as Tuesday (February 14) with the release of January’s Consumer Price Index. A reading in line with those of the past six months may just re-ignite the markets’ skepticism about future rate hikes.
Meanwhile, as the lags from the 2022 rate hikes, the choking off of growth in the money supply, and the tightening of credit by the banking system all kick in, the already sputtering economic engine are sure to stall.
Robert Barone, Ph.D.
(Joshua Barone contributed to this blog)