Herodotus of Halicarnassus supposed that Thales of Miletus was the first person to predict an eclipse, that of 585 BCE. That he did so is not contested so much as that he was able to, for at the time methods of calculation were rudimentary, and it is highly unlikely that he had access to the appropriate astronomical histories from which to build a model. Perhaps ancients frequently made predictions, and his legacy is handed down to us because he got lucky. But besides this extraordinary feat, he was also supposed to have learned to predict the seasons, too, on the basis of which he created futures or options contracts to have use of all the olive presses during a mast year. This second story adds to the veracity of the first, but his greatest legacy likely consisted in his use of math in prediction, proving that eclipses were events of Nature--not acts of the gods--and for which we know doubt owe him a great debt.
Earth-Shaking Jobs Numbers
Two earthquakes rumbled markets on Friday, April 5th: the first was the release of the Non-farm Payroll numbers for March; the second was a magnitude 4.8 earthquake with an epicenter at Lebanon, New Jersey. The first was caused by strong economic activity in the United States. The second was caused by the god of the sea, Poseidon, striking the earth with his Cyclopes-forged trident.* Neither were foreseen. Both caused consternation.
The US added 303,000 jobs in February, 100,000 more than consensus estimates. We had expected a large number of jobs based on recent economic strength as well as a strong ADP Private Payrolls report from Wednesday, but the actual number exceeded even our high expectations.
The uptick in payrolls probably has something to do with a reversal of recent weakness in Non-Manufacturing payrolls...
...as well as in the much smaller Manufacturing sector.
Initial Claims for unemployment insurance were only slightly higher. Recent wiggles in the data can be dismissed as noise. There's no real change in the Private Sector's need to cut jobs.
Similarly, we see no real change in the numbers of those who have been out of work for a month or more. The number of four week moving average of Continued Claims fell a bit but was statically indistinguishable from the prior period when it slightly rose.
Consequently, the unemployment rate fell by .1%--which is to say no change.
The Participation Rate improved by .2%, nearly reattaining its level at the end of 2023, but still well below pre-COVID--and, for that matter, pre-GFC--rates.
The Quits Rate was flat, a sign that most workers are satisfied with the terms of their employ, or else terror of the prospect of not being able to find a replacement...
...while Job Openings increased almost imperceptibly. This measure may begin to increase as the rate of hiring seems to indicate an increasing pace of growth.
Comparing the number of jobs available to the number of workers who are looking for work, we can see that Labor still maintains leverage in setting the wage rate, although the trend has been downward.
The reduced leverage is reflected in the fall in the rate of growth of wages. Wage growth is down on a year-over-year basis,
and up on a month-over-month basis. The continued strength in wage growth may be a problem for inflation, but it also contributes to workers' willingness to spend--providing an additional fillip to growth.
The labor market continues to exhibit strength, which presages continued economic expansion.
The Inflation Bogeyman Shocks Markets
We've now got a quarter of a year's worth of CPI prints in, which provides more clarity on the current growth and inflation picture. First, the PCE Price Index for February came in at 2.45% on a year-over-year basis, slightly higher than the prior month's reading.
On a month-over-month basis, however, inflation fell slightly from .38% to .33%. Since monthly changes are so much more volatile than annual rates or moving averages, we discount the slight fall. (If we were to annualize the difference between January and February, annualized inflation would have fallen a half-of-a-percent.)
Stripping out the impact of notoriously volatile components Food and Energy, Inflation was higher on a core basis. This is sticky inflation, certainly, at 2.78%...
...but when we remove the impact of Shelter inflation, we can see that inflation is behaving well, and is just .15% off of the Fed's target of 2%.
The Federal Reserve watches PCE as opposed to CPI because it is a better measure of what is actually bought--unlike the CPI, which is based on a basket of items. It, along with the GDP price deflator, are far better tools for measuring changes in the general price level.
So goes the Personal Consumption Expenditures Price Index--but what about the Consumer Price Index? We received those numbers on April 10, and they were not to the market's liking. First, headline CPI came in at 3.48% year-over-year, higher than the Fed's professed target rate.
While the year-over-year number was slightly higher than February's 3.17%, it didn't represent a departure from current trend, which is inflation bouncing around the sub-4% level--a level which the Federal Reserve recently commented that it was comfortable with, since it has recently communicated that it will take at least two years to return to inflation of 2%. But the market freaked out anyway, since it was a higher print, even if not by much--and we write 'freaked out', as the month-over-month change was actually lower (.38%) than it was the month prior (.44%). The other issue is that nearly half of the change in headline inflation on a year-over-year basis is down to increases in the price of always-volatile gasoline, and the price of shelter, which is flawed and on a lag.
The problem with looking at the year-over-year change is that it tells us more about where we were than where we are. If we instead examine CPI change on a six-month-over-six-month basis, we see that the Fed can land the fighter jet of interest rates on the aircraft carrier deck of monetary policy and declare "Mission Accomplished".
But returning to the year-over-year basis, we see that much of the problem is due to volatile elements as well as a price which no one actually pays: imputed rent. Stripping out food and energy, the CPI came in at a decidedly toasty 3.79%. That's certainly too high.
However, of what's left, the price of shelter comprises an even larger share, so core is even more distorted than headline due to the imputation of shelter prices. To wit, we submit Housing CPI:
We've written to what feels like ad nauseum about how the price of shelter is misleading in the CPI, runs a year late, and is partially constructed by asking homeowners how much they would rent their houses for--from themselves. We're by no means expert in survey construction, but we're willing to go out on a limb to state that the present method of capturing price change for shelter is 'silly', to use a term of art. Shelter inflation is still a big deal, and it is no doubt true that America doesn't have sufficient housing stock, but the picture of the current inflationary environment with the highest fidelity to reality is PCE excluding food, energy and shelter, and there we see that inflation is in a good place--for now.
The Fed has painted itself into a corner with its 2% inflation target; not because it has elected to set one, but rather because it has left the error band around that target undefined. Inflation in the 3 - 3.5% range isn't actually that high by historical comparison, and 1-year expected inflation is actually about 3% now, indicating that events are merely unfolding in the manner that Americans expect. Inflation at these levels and rates of change don't appreciably impact the consumption and saving decisions of workers, or the investment and hiring decisions of firms. The Fed has made the policy error of conditioning the market to overweight the importance of hitting the 2% inflation target on the nose. Market volatility is the result.
As a result of the 'hot' prints, the bond yield increased from 4.35% to 4.54%, seemingly giving back the cuts that had been expected, while the likelihood of an interest rate cut in June fell to a 20% probability, and a cut by July to 44%. The S&P 500 index lost about 1% of its value, and the short-rate sensitive Russell 2000 index of small cap stocks lost 2.5%. In our view, the market certainly overreacted, and because yields have pushed higher, the Fed is more likely--rather than less--to cut, since the market action has made financial conditions tighter than they were at the end of the day Tuesday.
PPI, Our Advance Inflation Measure, Cools
Just to create maximal confusion, we provide the Producer Price Index reading from April 11. PPI tells us what prices producers face when purchasing at wholesale, or investing in capital goods that are used in the production of the final goods that land in consumers' hands. It's a view of inflation in the pipeline, and excludes the prices of services, so it offers a clear window into commodity price pressures.
At 2.1% year-over-year, PPI looks like it's not setting off the same alarm bells that CPI did. It's also down markedly on a month-over-month basis, which gives us a sense of direction.
Looking at the three-month trend rate of growth, we can see that the trajectory has changed, which indicates that the next step in the trend will be down.
While we're not pollyannish about the prospects for near-term inflation, especially given the impact that higher oil prices and the risk premium it is earning due to events in the Middle East, we nonetheless don't see the cause for alarm that the market does. Interest rate cuts will still happen this year we believe, though they may be delayed by a month or two. Perhaps that leaves room for only one or two cuts this year as opposed to the three that were priced in a month ago. But come they will which is why we believe that the bond yield is very attractive at current yields, especially when compared to forward earnings yield on the S&P 500.
Our models suggest that the current rate of real growth has accelerated to about 3.75%. The ghost in the machine tells us that the level of employment and inflation is consistent with a higher level of growth, and that that growth is likely to continue at current levels absent an exogenous shock. Measures besides the unreliable CPI indicate that inflation isn't quite the problem it is now discounted to be, but that is merely an opportunity to build positioning in the longer end of the yield curve where inflation premium has pushed yields higher.
*Or, perhaps merely the release of energy due to the slippage of plates in a fault zone known as the Ramapo system--but in these post-science days, who can be sure? #liveyourtruth