Jonathan Marriott, CIO and Jeremy Sterngold, Head of Fixed Income
Predicting the size of falls in the economy last year was hard; predicting the monthly numbers as the economy recovers is proving even harder. I was reminded this week of a saying an economist shared with me many years ago: "Economists were invented to make meteorologists look good". This month, many economists may have felt similar to weather forecaster Michael Fish who laughed off suggestions that a hurricane was on the way the day before the great storm of October 1987 swept across the UK.
The most closely watched employment report, the US nonfarm payrolls, puzzled markets at the end of last week. The headline number disappointed markets in terms of job gains. Expectations were for one million Americans to re-enter the labour market. The reality was only 266,000. One of the biggest misses in terms of expectations relative to the result ever. However, many investors questioned whether this reflected the supply of labour rather than the demand for it, given the trends in wages. Earlier this week, the job openings report provided some further evidence that it may be the former, rather than the latter. With 7.5 million still out of work relative to February last year, the US Federal Reserve (Fed) will be puzzled by this, but it does support their “wait and see” approach. The other Fed objective, namely inflation, also came under close scrutiny this week. The much-anticipated May report, which contained a large amount of base effects, showed the headline level hitting 4.2% year over year, well ahead of the 3.6% expected. So how does the Fed square this data up?
Firstly, it is important to examine the US employment data in more detail. The generous fiscal packages expanded unemployment insurance benefits, and in the early days of the pandemic, some were financially better off than when they were employed. Whilst it has been cut further from those initial levels, the US federal government still tops up the state unemployment benefits. This raises the question as to whether claimants are making the deliberate decision to hold off from finding employment until the benefits expire, rather than working full time for an increase in pay. There is little evidence supporting that this is occurring; however, both Republicans and President Biden addressed the topic this week. Biden stated that people must take “suitable work”, meanwhile nine Republican Senators are seeking to end the benefits given the strong demand for workers. An approach that is unlikely to be effective in resolving the matter of unemployment. The pandemic continues to contribute; despite the impressive vaccination rollout, many still have healthcare concerns, childcare or other carer responsibilities, which may deter them from returning back to work. The pandemic has completely warped the supply and demand dynamics, and the labour market is not immune to that.
Secondly, the inflation data has to be seen in a similar light. Some of the largest increases that were seen over the month of April were in Airfares (10.2%), Hotels and other lodging costs (8.8%) and second hand cars (10%). The first two factors are dominated by less availability as capacity has been reduced to the pandemic, and as restrictions ease, demand for these have soared. Used cars have not just benefitted from the stimulus cheques and increased level of savings, the supply of new cars is also more challenging due to shortage in semiconductor chips. On the other hand, owner equivalent rent rose a very modest 0.2% and is only up 2% year over year. This may be impacted by strong housing markets outside the larger cities driving a decline in inner city rents. This partly demonstrates the unique nature of the pandemic, which has brought the long established urbanisation trends into question.
Coming from the fastest sharpest recession in history to, in some places, one of the strongest recoveries, aided by fiscal and monetary policy, we should expect the survey data to be volatile. While markets should look at long-term trends, they inevitably react to short-term numbers. Last year we advised investors to look through the noise of the down side and to sit tight. This year we urge investors to do the same when markets react to short-term volatility in economic data.
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