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Markets are still rosy on the Fed

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Good morning. Jenn Hughes here, helping fill in while Rob is away. New US mortgage rates have now spent four weeks above 7 per cent for only their third such run this century. Yet new home loan applications ticked up for the first time since July. A sign of desperation, or simply resignation that this is the new normal? Email me:

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Hard work

The data calendar has ensured this week is in effect “Jobs Week” for US markets even if Americans weren’t about to enjoy the annual Labor Day holiday on Monday.

This week we’ve had government data registering a drop in job openings in July and a similarly soft message from the monthly (if noisy) ADP private payrolls report. The quits rate is back at 2019 levels. The all-important yet hard-to-predict non-farm payrolls numbers, due on Friday, are expected to show monthly job gains of 170,000 in August, a more moderate pace.

Stocks and bonds have liked what they’ve seen. Ten-year Treasury yields dropped to their lowest in more than two weeks on Wednesday at 4.1 per cent. A gradual easing of tight labour markets bodes well for the Federal Reserve’s battle against inflation, and thus for investor hopes of a soft landing. The S&P 500 has added 2.5 per cent since Monday, helped by hopes that weaker data will hasten interest rate cuts. If the index holds around where it closed yesterday, that would be its best week since mid-June.

Investors are betting that the status quo on interest rates persisting is a likelier outcome than a further quarter-point rise, but only just. The blue line in the chart below shows the market-implied probability of rates remaining where they are by year-end, while the pink line shows the chance of another increase. We’re not far from 50/50:

Line chart of Probability (%) of the target range for the federal funds rate by year-end showing Future Fed (well, December)

That brings us back to jobs, and the data “stars” Jay Powell said last week that the Fed was navigating by, under cloudy skies.

This week’s data suggests a trend most would welcome: moderating but still-decent jobs growth. But what if the labour market has changed structurally and the data isn’t reflecting that? 

That’s the fear of Michael Arone, chief investment strategist at State Street Global Advisors, who lists five reasons for thinking there are deep changes. Those are:

  1. A drop in female labour force participation

  2. Fewer foreign-born workers

  3. Rapid boomer retirement

  4. Small businesses’ ongoing struggles to find suitably skilled labour

  5. The rise of the gig economy

Asked to narrow it to the very biggest issues in the interests of Unhedged’s word count, Arone picked boomers and small businesses.

“Baby boomers retiring early takes out experience and skill, and it reduces the labour supply. Then, small businesses tend to be the drivers of job growth. And if they’re not able to find skilled, qualified workers, that concerns me about the future of labour growth. To me, those two are the big ones. The other ones are somewhat more demographic or could be addressed through policy,” he said.

Surveys by the National Federation of Independent Business show that 42 per cent of their members in July had at least one position open that they could not fill since June:

Grey bars are recessions. It’s natural that businesses cut hiring or more rapidly fill roles — or both — heading into downturns and sometimes well ahead of them.

But these historically elevated levels suggest there’s something more going on. Since job openings are easy to cancel, those unfilled openings could have fallen much faster had business owners feared for their future if high borrowing costs were crushing their funding.

So, a structural problem in hiring? Possibly. It certainly bears watching.

Boomers are harder to find current data on. Government figures show a strong belief that older groups will want, or need, to keep those paychecks coming for longer, even as they predict an overall drop in participation because of an ageing workforce.

Bar chart of Percentage participating in the workforce by age group   showing Retirement? In statisticians' dreams

It’s notable, too, that the chart shows how older groups’ participation didn’t really increase between 2011 and 2021, even as more are expected to be still working by 2031.

The Bureau of Labor Statistics release doesn’t say why it believes boomers will crack on rather that sit back. A Pew Research Center study in late 2021 cautioned that the number of retirees aged 55 and over actually began ticking up after 2019 in its first upturn in 20-odd years.

The number of retirees over 55 was growing by about 1mn a year by 2019. In 2020 and 2021, during the pandemic, that rose to 3.5mn a year.

Structural? Maybe. Robust house prices and a decent economy have no doubt helped with dreams of moving to the nearest Margaritaville. A downturn could just as easily force others to delay their plans to down tools.

Still, workers in this post-pandemic world have shown so far that lifestyle choices have the power to trump cold, hard economic logic. Just ask the banks trying to get workers back into the office five days a week.

Back to the Fed and what underestimating structural labour shifts might mean for monetary policy. Overly rosy data such as an unemployment rate holding near its current 3.5 per cent could in theory encourage Powell & Co to hold interest rates higher for longer than the underlying economy can easily bear.

More likely, though, is that a still-buoyant jobs market boosts wage rise expectations and makes it harder for the Fed to rein in inflation.

Here’s Powell last week on inflation just before he mused on the stars and cloudy skies:

It remains too high. We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down towards our objective.

That’s a fairly emphatic “no” to the idea the Fed is yet anywhere near declaring victory. The reaction this week to the data suggests the market is hoping otherwise.

One good read

How UBS’s Colm Kelleher reached that awkward handshake in March with Credit Suisse’s Axel Lehmann.

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