Baker Market Update
2022-09-02

Bond yields drifted higher this week as markets continued to digest the blunt words of Fed Chairman Powell last Friday regarding the central bank’s “overarching focus” on fighting inflation even if it involves a lengthy and painful process. New York Fed President Williams reiterated on Tuesday that we should expect restrictive policy for some time, and that the size of the next rate hike will depend on the totality of income data. Some of that data came this morning with the August employment report which showed that a healthy 315K new payrolls were created for the month, but because of an uptick in labor force participation the unemployment rate jumped two-tenths of a percent to 3.7%. The participation rate is key to understanding how much slack remains in the labor market, and there clearly seems to be room for more people to re-enter the workforce. At 62.4%, participation remains well below pre-pandemic levels, but it’s grinding higher. Overall, with total employment now above pre-pandemic levels, it seems that job creation is on a sustainable but slowing pace. The wage component of the report showed a 5.2% YOY change in average hourly earnings, lower than expected and fairly benign in the current environment. So as summer comes to an end, the labor market is healthy… but keep an eye on what’s coming down the pipe. Remember, less than six months ago the Fed Funds rate was near zero…. Now it sits at 2.50%. That substantial increase in overnight borrowing cost is just now starting to filter through into the” real economy”, and it will no-doubt hit the jobs market.

As Gary Shilling and others have noted, a growth downshift is already well underway. Real wages (adjusted for inflation) have declined every month for well over a year, and though nominal retail sales have risen nearly 7%, they are down over 4% when adjusted for inflation. We’ve also seen five consecutive months of decline in leading economic indicators, and the banking system has experienced a massive drain of reserves as the Fed has tightened. To be sure, the cessation of fiscal stimulus at the end of last year combined with the 225bps of rate hikes since March have begun the process of demand destruction, but much more will be seen before it’s all over. Indeed, the only reason not to call this a recession is that GDI (Gross Domestic Income) remains positive, a lingering effect of the enormous ’20-21 fiscal stimulus. That will not last. Recession, however defined, is here or soon to arrive.

Earlier in the week, we also got fresh data on Durable Goods Orders (which were slightly negative) and Capital Expenditures (up less than expected). Also, consumer sentiment unexpectedly rose, and the ISM Manufacturing Index remained above 50%. Productivity growth, however, remained near historic lows. Next week we’ll get updated numbers for consumer and producer price inflation… key inputs for the Fed.

US Labor Force Participation Rate: 2005 – Today