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Can the latest US jobs and inflation data suggest that the economy is heating up and cooling down at the same time?
I feel compelled to aplogise to readers about the disproportionate focus of my blog posts on the US. Sorry! Justification for this focus, at least partially, is that the US is, for many reasons, the world's most important economy. Relatedly, it has the best data in terms of breadth, history and accessibility/delivery - if you haven't got the FRED Excel add-in I highly recommend it!
There have been important data releases in recent days relating to jobs and inflation.
Last week, it was announced that a net 528,000 jobs had been created in July - versus expectations of 228,000 - and that unemployment had fallen to a very low 3.5pct. This week, inflation data came in better - lower - than expected. US equity markets were unfazed by the former and pleased with the latter. US bonds hated the former and were unfazed by the latter. Dearest Erwin, please come and get your damned cat!
While one may be tempted to deem the data contradictory and the markets' reactions irrational, it is more likely that both can be explained logically.
It seems that there may be two independent forces at work simultaneously. One is the seemingly relentless demand for labour related to, among other things, repatriation of supply chains, that is pushing down unemployment but that has not yet pushed up wage growth, at least not significantly. The other is the fall in gasoline prices that has brought the headline but not the core inflation number down.
As for market reaction, the hotter jobs numbers would have been interpreted by bond markets to mean even tighter monetary policy ahead as well as the economy being generally hotter, i.e. they impacted both short and long ends of the curve. Equity markets, on the other hand, saw no reason to think that the tigher jobs market meant that the risk of a hard landing had increased.
As for the inflation number, equity markets deemed it to be positive - a sign that the end of the tightening cycle was in sight. As for bonds, the implications of the better than expected inflation may have been more for the short end of the curve than the long end, as indeed was the case.
Or perhaps there is some other logical explanation. Or perhaps there is no logical explanation. Who knows?!
Regardless, my view, as I have set out in previous posts, is that in the next year or so, inflation will fall as a result of a hard landing recession but that longer term we will be living in a world of structurally higher and more volatile inflation - this paper, entitled, The Burst of High Inflation in 2021–22: How and Why Did We Get Here? is an excellent read and makes the emminently valid point that the period of low and stable inflation seen across much of the world during the last 20 or more years has been the exception rather than the norm.
My view has also been that the end of the tightening cycle is not yet in sight i.e., inflation has not yet peaked, but I could be wrong about this. It is certainly possible that the July inflation numbers will turn out to have signified the peak but it is also possible that this is not the case. Getting the timing of inflection points precisely right is hard if not impossible.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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