It was a bit strange to watch the market's reaction to the jobs report when it crossed at 8:30 this morning. Similarly strange to how it felt watching the initially bullish reaction to Powell's dovishness on Wednesday. I say so because this is not the 2010s anymore. Back then, we were desperate for growth. We had no inflation. "Secular stagnation." Remember all that? It made sense back then for markets to rally whenever we either had strong data or dovishness from policymakers. But It Doesn't Make Sense Anymore.
You can see the last traces of the old trading patterns fading away this week. That initial excitement after Wednesday's Fed press conference, that sent the Dow up over 900 points by the close? Gone, and then some, with yesterday's massive selloff. The market's initial jump higher in response to the strong jobs report this morning? It lasted barely 60 seconds.
Why on earth would we want the Fed to rule out a 75-basis-point rate hike right now, when it insists it's trying to "expeditiously" tighten policy? Why would we want the jobs report to show another month of more than 400,000 jobs gains right now, with annual wages for non-supervisory workers spiking 6.4% from a year ago--and still trailing the inflation rate? "Good news" is no longer good news--and it's certainly not bullish--if it means the Fed is falling further behind the curve and will have to tighten more in the future, risking a deeper downturn.
This is exactly what Bank of America's Ethan Harris--who got mocked back in January for his correct call that the Fed would have to hike seven times this year--warned about before the jobs report hit this morning. "By many metrics, the labor market is now the tightest in modern history," he wrote. The resulting wage pressures are broadening inflation; the "trimmed mean" PCE measure that policy makers like Lael Brainard follow has gone from 2% last year to 3.7% as of March, per Harris, and is "likely to continue rising."
"This puts us in the odd position of hoping for soft employment reports," Harris wrote (emphasis mine). "The tighter the market gets," he warned, "the greater the need" for the Fed to tighten next year in order to pull inflation back towards its target.
The labor market is already so tight that the Fed basically has no choice but to slow it down, or in other words, to raise the unemployment rate. They've never in the past successfully done so without triggering a recession. But Fed Chair Powell this week held out hope that because the number of job openings is currently so high, the Fed can basically try and "knock out" those openings to help cool wage pressures before having to actually destroy jobs. Economists like Harris are wary they can pull this off.
In order to raise the unemployment rate by 0.1% per month, Harris wrote, the Fed would need to slow job growth to just 25,000 per month--and that's only if labor force growth remains as strong as it has been (around 200,000 per month). But if labor force growth slows--as it did this morning--then the window for job gains at all likely disappears. If labor force growth falls below 100,000 a month--its long-term trend--the Fed "will need to push job growth to negative 70,000" per month, Harris warned. "That is, they would need to trigger a mild recession."
Knowing all this, the usual "bullish" market gauges no longer apply. Even the yield curve falls into this category. The three-month/ten-year U.S. Treasury spread has blown out to a fresh seven-and-a-half year high in the wake of Powell's dovishness this week. That, in other words, is a signal of an economic boom coming. Do we want nominal demand booming even more right now?! Of course not!!
Demand booms that outpace what the economy can produce are simply inflationary. We can have a whole debate about how the government can try to make supply-side reforms to unleash greater productive power (typical examples include lower taxes and less government regulation) -- but there's no point, because the Biden White House is basically the exact opposite of the Reagan administration that pursued those reforms after the last inflationary shock of the 1970s. That leaves only the Fed with the power to "fix" this crisis by slowing demand--and their $4.5 trillion of stimulus itself bears plenty of responsibility for creating this inflation today.
The old playbook doesn't work anymore. "Strong" jobs data isn't the joy that it once was. The markets see the conundrum we're in.
See you at 1 p.m!
Kelly
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