November 2021
Undoubtedly, the most important economic release of the month is the jobs report on the first Friday of the month. Jobs drive the economy! The November report was a bit of a “headscratcher” though. The general public and media look to the nonfarm payrolls as the lead indicator of job gains and in November that number came in well below expectation, registering 210,000 new jobs versus an expectation of 531,000. That statistic is based on a survey of businesses. The Bureau of Labor Statistics also releases an employment measure based on a survey of households and that measure showed a gain of 1.1 million new jobs in the month, significantly above expectations and the polar opposite of the nonfarm farm result. Moreover, the household report showed that 594,000 persons reentered the workforce and, as a result, the unemployment rate fell to 4.2%; down from 6.3% in January of this year and well below the 14.8% rate registered in April 2020. So based upon that report, either the economy is slowing and we can expect to be back at trend growth, or its rapid growth is showing no sign of slowing. We believe the latter to be true. Further driving home the growth acceleration argument was the Institute for Supply Mangers Services survey which registered 69.1, an all-time record.
This makes the job as Fed Chairman more difficult for Jerome Powell. Giving away free money makes people happy as they see the value of their personal balance sheet expand. When the Fed reverses course and begins to drain money from the system, asset prices tend to reverse and that makes people unhappy. The Fed has engineered, by any measure, a flood of liquidity into the monetary system and they’ve just begun to ease up on liquidity injection via taper. Tapering asset purchases is not the same as tightening. When the Fed raises rates, they do so by selling bonds into the open market, taking dollars out of circulation. Based on the size of their daily reverse repo operation, they’ll need to take $1.4 trillion dollars out of the system before even making a dent in short-term interest rates. Of course that measure is based on how the Fed once operated, when monetary policy was in equilibrium. We expect that they’ll ignore the current imbalance and synthetically raise the rate corridors. The markets, according to Fed fund futures, are betting that the first Fed Fund rate hike will occur by March 2022, with two hikes in 2022 and another two in 2023. Given the public communications of the various Fed Governors and Presidents, we expect that the FOMC will announce a more aggressive rate of taper at the conclusion of the December meeting.
Initially stocks did not react well to the prospect of early rate hikes, but the S&P has since rallied and sits just below an all-time high. Bond traders, on the other hand, are delighted at the prospect. The 2-year/30-year yield curve spread has fallen to 109 basis point from 229 basis points earlier this year. Taking a page out of the rate hike playbook, traders flatten the curve when the Fed becomes hawkish in anticipation that the rate hikes will dampen inflation. We think it’s much too soon to assume that Powell and company will have the wherewithal to fight inflation to the degree that will be needed.
As an aside, Fed President’s Mester and Bullard, will be participating as voters on the FOMC in 2022. Given that both are somewhat hawkish in view of monetary policy; the potential exists for the committee to pursue a more restrictive monetary policy. Especially, if the economy continues to run hot and inflation continues to surprise to the upside, which we believe will be the case.
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