A Blowout Jobs Report Defies Omicron Surge
A weak forecasted January jobs report came in well above the rosiest of predictions. The US added 467,000 jobs versus 125,000 expected, bringing the unemployment rate to 4%. In addition, the previous three months were revised upward by a total of 840,000 jobs. The red-hot labor market has not come without costs. Employers, contending with higher inflation and a smaller labor pool, are raising wages at the fastest pace in decades. Average hourly earnings surged in January by .7%, bringing the 3-month annualized gain to 6.6%. Workers continue to change jobs in record numbers in search of higher wages and better working environments. This could lead to a permanent shift in the occupational composition of the labor force. For example, teachers are fleeing the profession in record numbers for higher-paying sales and corporate training jobs. The disruptions caused by these shifts may have serious societal consequences and could take years to resolve.
Economic activity cooled slightly in January as COVID infections surged. Both ISM surveys were down from recent highs on slower demand and a reduced backlog of orders. The prices paid component remained elevated in both surveys dashing hopes of a lower trend for inflation in the near term. Higher oil prices, wages, and producer prices all point to sticky inflation over the coming months. There are emerging signs that the supply chain problems are righting as delivery times improve. Further progress should help reduce many core inflation components over the medium term. Higher prices, especially at the gas pump, along with pandemic fatigue, have added to a sense of malaise for consumers. A recent poll showed that roughly 75% of Americans expect a recession over the next 12 months. While a recession is an improbable outcome, such a dire consumer outlook could hurt the recovery that has gone unabated to date.
The Federal Reserve has the impossible task of engineering a soft landing in the coming months. They will need to simultaneously balance ending asset purchases (QE), increase the Fed funds rate, and begin the roll off of balance sheet assets (quantitative tightening), all in the face of waning fiscal stimulus. A Fed policy mistake has been our top risk call for the past six months. The Bank of England recently raised their benchmark rate by .25% by a 5 to 4 vote, with four members asking for half a percent (.5%) increase. We believe a measured rate hike schedule is prudent, but hawkish voices are gaining strength. The market choppiness is likely to continue until we get more clarity on the Fed’s path.
Bottom Line: The underlying economy is strong with healthy corporate and consumer balance sheets. There remains a disconnect between commonly perceived and actual economic strength, which could weigh on consumer spending until resolved. Hopefully, the Fed will remain patient while sorting through the inflation puzzle, but a policy mistake is in the cards. Volatility is likely to continue through the first half of the year but expect risk assets to outperform in the end. We remain underweight duration as interest rates will march higher over by year’s end.