VTI - Don't Focus On Jobs

2023-07-07 09:55:56 ET

Summary

• The market has been looking for an excuse to consolidate first-half gains, and stronger-than-expected economic data is the excuse.
• The jobs data is not as strong as perceived, but it should not be the Fed's focus when addressing inflation.
• Excess savings has been the fuel for services inflation, and its decline will do the Fed's job for it.

We needed a pullback in the index averages to consolidate the outsized gains from the first half of this year, and stronger-than-expected economic data in combination with hawkish Fed commentary are instigating it. As expected, the incoming data is typically too weak, as in manufacturing, or too strong, as in labor, to assuage fears of either recession or further monetary policy tightening. Yet a balance of the two is what helps the economy navigate a soft landing. Yesterday's dose of "too strong" came in the form of ADP's payroll report .

I'm not overly concerned about the 497,000 jobs created in June, which was almost double the expectation, because it was not that strong if you look behind the headline number. Nearly half were created in the leisure and hospitality sector. One of those jobs was given to my 19-year-old son, who is working for a staffing company this summer and earning approximately $18/hour. How many of these short-term and low-wage positions does it take to offset the loss of one full-time career post in the financial, technology, or manufacturing sector? The short answer is a hell of a lot.

Still, the perceived strength of this report sent bond yields soaring with the 2-year yield surpassing 5% and the 10-year yield back above 4%. Rising yields sent stocks prices south, but the outlook for monetary policy did not change very much at all. The futures market was already predicting another rate hike at the end of this month to 5.25% with a near certainty, but the probability of a rate cut by year end did fall. Given the volatility in long-term expectations, I think it is ill-advised to base any decisions on such data. If short-term market expectations hold, the Fed will likely follow through with another rate hike, as Fed Chair Powell does not like to disappoint markets. I think this would be a mistake.

In addition to this week's ADP payroll report, we had the Job Openings and Labor Turnover Survey ((JOLTS)) report for May , which showed that openings fell 496,000 to approximately 9.8 million. That works out to 3.7 million more jobs than unemployed workers compared to the peak of 6.1 million in March 2022. Therefore, the openings as a percentage of the labor force has fallen from a peak of 7.3% to 5.9%. This still exceeds the pre-pandemic level of 4.3%, which is what Chairman Powell would probably like to see. The JOLTS report shows the labor market is still tight, which could put upward pressure on wages, which is what concerns Fed officials in their fight to return the rate of inflation to 2%. I think they are focusing on the wrong data.

This morning's establishment report revealed a much weaker scenario than ADP, as job creation for the month of June fell to just 209,000 . More importantly, revisions to the prior two months reduced the job count by 110,000, which nets us a gain less than 100,000 jobs. Wage growth held steady of 4.4%, while the length of the workweek increased modestly. This is another goldilocks report, as we have enough strength to assuage concerns about recession, but there is also a softening that should ease concerns about the inflation. That said, this is not the data to focus on.

Granted, more jobs and more income results in greater demand for goods and services, but there is an anomaly that defines this business cycle more than any other. It is the mountain of excess savings that built up following the pandemic-driven recession in 2020. This mountain exceeded $2 trillion and it was directed towards spenders rather than savers. As a result, we saw a surge in spending on services that continues to this day, as the drawdown on excess savings is not yet complete. Economists at the San Francisco Fed estimate the remaining balance to be approximately $500 billion. I think this has been the primary fuel for the services-related inflation that concerns the Fed the most.

The consensus expects this excess savings to be worked down to pre-pandemic levels by the end of this year, which is when I expect to see a pre-pandemic balance return between spending on goods and services. The bears anticipate this development to result in recession, but real-income growth is also returning as inflation falls, which should help sustain the real spending growth needed to continue the expansion.

The Fed's job is done, but I suspect Chairman Powell will follow through with one more rate hike provided the market expects it after today's jobs report. That won't change my outlook for a soft landing or continuation of the bull market, but any additional rate hikes probably will, as the Fed will have swung the pendulum from too loose to too tight once again.

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