We had another strong jobs report, which will put additional pressure on the Federal Reserve to “cool-off” the market. Powell said this week that they don’t see a wage spiral as a potential problem, but the data is showing something that is concerning and contradictor to his comments. The market had a big correction after rallying hard post the Federal Reserve conference. In my opinion, the rally was caused by a short squeeze because his underlying commentary wasn’t bullish. Every part of the U.S. economy as measured by the PCE is seeing a rise in pricing- even the ones that have demand BELOW pre-COVID levels. This helps to highlight that demand isn’t the only thing driving up prices, but wages and supply chain costs are continuing to do their damage.
Typically, wages rise during peak job-hunting season March thru June. At this point, budgets have been refreshed and bonuses fully paid out so people who want a pay raise or title bump will look to move on. It isn’t surprising to see people getting a sizeable bump in salaries as they switch- especially given how tight the job market remains.
The change in payrolls (job additions) came in above estimates at 428k people vs estimates of 380k. The additions were broad based with no one specific area doing the heavy lifting.
You might be wondering- why is the market falling again on a positive number? The Fed has two directives- 1) keep inflation within target (which was set at “about” 2%) 2) attempt to keep employment at the “natural rate.” There will always be companies conducting layoffs and people quitting their jobs so unemployment is never 0% but rather something between 4%-4.3% is deemed “natural.” When you fall below that number- we are at 3.6%- it means the job market is running hot. In short, we have inflation running at near 8% and employment at 3.6%… we are the definition of overheating right now. Even in this backdrop, Powell raised rates .5% and doesn’t see a wage spiral being created.
What is a wage-spiral? It is a self-feeding loop where companies increase wages to match living expenses, but in raising wages they attempt to pass on the new cost by increasing prices that pushes living expenses higher. Once you get into a spiral, it takes a more drastic action to break the cycle to stop the inflationary push and bring everything back under control. In order to break the cycle of the 70’s, Volker pushed Fed Fund Rates from 11% to 20% in order to effectively break the cycle. We are currently at 1%… just to put that in context. We are in a different world and not saying a double digit is in the cards, but it gives perspective of where we sit vs historics.
There are many pervasive issues in the market but food and energy prices remain front and center. Diesel prices are at record levels with little to cause it to break stride keeping prices for goods around the world shifting higher. It takes diesel to
1) Mine the raw materials
2) Move the materials to the processing plant
3) Ship the raw materials or semi-finished goods to the next part of the process
4) Create the finished product
5) Ship the finished product to the wholesaler or consumer
6) Ship to its final destination
Each step passes on the price of labor and fuel- both of which have surged from to record levels. It isn’t just the net price but the “rate of change” that has also shocked the market creating a significant bump in pricing.
Food has surged to all time highs, and given the shifts in recent yield estimates- the new number coming out in June will show another push to records. The “Peasant Uprising” started in 2011 the last time we hit a new high, and the current prices BLEW through those previous highs. We are looking at another lean year in yield, which would make the 2/3rd year in a row of not having a bumper crop. Russia-Ukraine is just making a bad situation worse, but even if there is a cease-fire- the damage has been done for this planting year.
The U.S. consumer is feeling this pain, which has caused a big drop in consumer confidence and surprisingly at the highest income bracket. This is the income level that generates the most spending in the U.S, and if they are starting to worry- it is one of the first signs things are going to slow much faster.
Some of this concern is showing up in the savings rate vs revolving credit. As prices have moved higher, savings rates have dropped off considerably and reliance on credit has exploded higher. Another way to say it- consumers are relying more on credit to cover the rise in pricing.
We are seeing that in different parts of the consumer credit world:
There was a dip in retail sales week over week that we will have to keep track of to see if this is just a blip or a sign of something bigger to come.
As we discussed earlier, EM issues are getting worse with USD strength and weakness in the global market. Leverage is rising as government deficits are covered by issuing new debt and current debt is rolled at rising interest rates. This is putting more pressure on balance sheets as the interest expense grows and stretches the government balance sheets. This is why we think subsidizes are rolled back much faster as the pain spreads.
The dollars rise to over 103 mixed with the 10-year treasury over 3% is going to hit emerging markets in a big way. The drop in spending in developed markets (especially the US) will keep pressure on the global economy as it drags trade lower.
Regards,
Freedom Financial News
