Tag: Job Openings

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Rising Crude and Gold warn of inflation

Brent crude continued its advance, closing at almost $89 per barrel on Tuesday. Our target is $94 per barrel would increase inflationary pressure in the months ahead and possibly delay Fed rate cuts.

Brent Crude

Rising crude oil prices have forced cancellation of plans to restock the strategic petroleum reserve (Bloomberg). US crude and petroleum inventory (including SPR) is testing the lows from January 2023.

Crude & Petroleum Inventory

Treasury Market

10-Year Treasury yields broke resistance at 4.35% but is retracing to test the new support level. Respect would confirm an advance to test resistance at 5.0%. Failure of support is less likely but would warn of another test of 4.05%.

10-Year Treasury Yield

Federal debt at 120% of GDP, deficits of 6% of GDP, and a growing interest rate burden limit the available options.

Federal Debt/GDP

The Fed can suppress long-term interest rates but the cost — in terms of inflation — is likely to be high.

Federal Debt Interest Burden

The US is well along the path to fiscal dominance as explained in this 2023 paper from the San Francisco Fed:

Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low….If global real interest rates returned tomorrow to their historical average of roughly 2 percent, given the existing level of US government debt and large continuing projected deficits, the US would likely experience an immediate fiscal dominance problem. Even if interest rates remain substantially below their historical average, if projected deficits occur as predicted, there is a significant possibility of a fiscal dominance problem within the next decade.

The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.” Fiscal dominance leads governments to rely on inflation taxation by “printing money” (increasing the supply of non-interest-bearing government debt).

The rise in Gold — currently at $2270 per ounce — reflects bond market fears of an inflation rebound.

Spot Gold

The same inflation fears are also driving demand for stocks.

S&P 500

US Economy

The US economy continues to display resilience, with job openings holding steady at 8.8 million in February, exceeding unemployment by a wide margin of 2.3 million.

Job Openings & Unemployment

Light vehicle sales remain robust at a seasonally-adjusted 15.8 million annual rate in February, reflecting consumer confidence.

Light Vehicle Sales

However, heavy truck sales (41.6K in February) are trending lower — with the 6-month moving average crossing below the 12- month MA — reflecting declining business confidence.

Heavy Truck Sales

Conclusion

The economy remains robust but fears of an inflation rebound are growing, fueled by rising crude oil prices and large fiscal deficits. The odds of Fed rate cuts in the second half of the year are shrinking but there are still two possible scenarios:

  1. A sharp decline in economic activity could still prompt the Fed to cut rates despite inflationary fears. That would be a strong bear signal for stocks.
  2. Fiscal dominance, with the deliberate use of inflation as a tax in order to restore the ratio of debt-to-GDP to more sustainable levels. This involves shrinking the public debt in real terms by expanding GDP through inflation. A strong bull signal for real assets such as Gold, Stocks and Commodities.

Acknowledgements

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Core PCE surprise jump

Monthly core PCE — the Fed’s favorite measure of underlying inflation — jumped by 0.416% or 5.0% annualized.

Core PCE - Monthly

Annual figures are still declining, including the Trimmed Mean PCE which declined to 3.2%.

Core PCE & Trimmed Mean PCE

The 3-month (orange) and 6-month (gray) moving averages have turned upwards but not yet crossed the descending annual line (red).

Core PCE - Moving Averages

Services PCE — which tends to be the most persistent inflation — jumped even higher in January, reaching 0.596% or 7.2% annualized.

Services PCE - Monthly

The 3-month (yellow) and 6-month (gray) moving averages have crossed above the descending annual line (orange), warning of a trend reversal.

Services PCE - Moving Averages

The resilient US economy warns that the spike in January inflation may not be an anomaly. Financial conditions remain easy, with the Chicago Fed index at a low -0.518.

Chicago Fed Financial Conditions Index

Real personal disposable income per capita declined slightly in January but remains in an up-trend.

Real Personal Disposable Per Capita Income

Real retail sales are on trend.

Real Retail Sales

The labor market is tight, with job openings exceeding unemployment by close to 3 million.

Job Openings & Unemployment

Container rail freight (blue) has been climbing since Q2 of last year.

Rail Freight

Heavy truck sales rebounded in January after weakness in September-October last year.

Heavy Truck Sales (units)

Gold

Gold jumped to $2044 per ounce on higher inflation expectations. Another test of $2060 is likely.

Spot Gold

Conclusion

January core PCE warns that inflation is not dead and is likely to rebound in 2024. Easy financial conditions underpin a robust recovery, with a tight labor market, retail sales at trend, and signs of improving economic activity.

The economy is likely to remain robust for as long as Treasury floods financial markets with liquidity — ahead of the November elections.

A resurgence of inflation would increase pressure on the Fed to hold rates steady for longer. Further rate rises are unlikely — unless there is a massive spike in PCE inflation — but it is also possible that we don’t see rate cuts before the fourth quarter.

Acknowledgements

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Copper breaks support while crude gets hammered

Copper broke support at $7900/tonne, signaling a primary decline with a target of its 2022 low at $7000. The primary down-trend warns of a global economic contraction.

Copper

The bear signal has yet to be confirmed by the broader-based Dow Jones Industrial Metals Index ($BIM) which is testing primary support at 155.

DJ Industrial Metals Index ($BIM)

Crude oil

Crude fell sharply this week, after a 3-month rally.

Nymex Light Crude

The fall was spurred by an early build of gasoline stocks ahead of winter, raising concerns of declining demand.

Gasoline inventories added a substantial 6.5 million barrels for the week to September 29, compared with a build of 1 million barrels for the previous week. Gasoline inventories are now 1% above the five-year average for this time of year….. production averaged 8.8 million barrels daily last week, which compared with 9.1 million barrels daily for the prior week. (oilprice.com)

Gasoline Stocks

Crude inventories have stabilized after a sharp decline during the release of strategic petroleum reserves (SPR).

EIA Crude Inventory

Releases from the SPR stopped in July — which coincides with the start of the recent crude rally. It will be interesting to see next week if a dip in this week’s SPR contributed to weak crude prices.

Strategic Petroleum Reserves (SPR)

Stocks & Bonds

The 10-year Treasury yield recovered to 4.78% on Friday.

10-Year Treasury Yield

Rising yields are driven by:

  • a large fiscal deficit of close to $2T;
  • commercial banks reducing Treasury holdings; and
  • the Bank of Japan allowing a limited rise in bond yields which could cause an outflow from USTs.

Bank of Japan - YCC

The S&P 500 rallied on the back of a strong labor report.

S&P 500

The S&P 500 Equal-Weighted Index test of primary support at 5600 is, however, likely to continue.

S&P 500 Equal-Weighted Index

Expect another Russell 2000 small caps ETF (IWM) test of primary support at 170 as well.

Russell 2000 Small Caps ETF (IWM)

Labor Market

The BLS report for September, with job gains of 336K, reflects a robust economy and strong labor market.

Job Gains

Average hourly earnings growth slowed to 0.207% in September, or 2.5% annualized. Manufacturing wages reflect higher growth — 4.0% annualized — but that is a small slice of the economy compared to services.

Average Hourly Earnings

Average weekly hours worked — a leading indicator — remains stable at 34.4 hours/week.

Average Weekly Hours

Unemployment remained steady at 6.36 million, while job openings jumped in August, maintaining a sizable shortage.

Job Openings & Unemployment

Real GDP (blue) is expected to slow in Q3 to 1.5%, matching declining growth in aggregate weekly hours worked (purple).

Real GDP & Hours Worked

Dollar & Gold

The Dollar Index retraced to test new support at 106 but is unlikely to reverse course while Treasury yields are rising.

Dollar Index

Gold is testing primary support at $1800 per ounce, while Trend Index troughs below zero warn of selling pressure. Rising long-term Treasury yields and a strong Dollar are likely to weaken demand for Gold.

Spot Gold

Conclusion

Long-term Treasury yields are expected to rise, fueled by strong supply (fiscal deficits) and weak demand (from foreign investors and commercial banks). The outlook for rate cuts from the Fed is also fading as labor market remains tight.

The sharp drop in crude oil seems an overreaction when the labor market is strong and demand is likely to be robust. Further releases from the strategic petroleum reserve (SPR), a sharp fall in Chinese purchases, or an increase in supply (from Iran or Venezuela) seem unlikely at present.

Falling copper prices warn of a global economic contraction led by China, with Europe likely to follow. Confirmation by Dow Jones Industrial Metals Index ($BIM) breach of primary support at 155 would strengthen the bear signal.

Strong Treasury yields and a strong Dollar are likely to weaken demand for Gold unless there is increased instability, either geopolitical or financial.

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CPI dips but rate hikes likely to continue

CPI dipped to 8.5% for the 12 months to July. But this still leaves the Fed way behind the curve, with a real Fed funds rate of -6.0% (8.5%-2.5%).

CPI

Monthly CPI figures, however, show a sharp slowdown, with CPI falling 0.01% in July (-0.14% annualized rate).

CPI Monthly

The primary cause is energy prices, which fell 4.53% in July (-54.7% annualized rate).

CPI Energy (Monthly Annualized)

Food CPI continues to climb, up 1.06%for July (12.75% annualized rate).

CPI: Food

CPI Shelter, heavily weighted at 32.1% of the total CPI basket, remains a major source of upward pressure on CPI. The Shelter index tends to lag home prices by up to 12 months and the Case-Shiller 20-City Composite Home Price Index grew at 20.8% for the 12 months to May.

CPI: Shelter

The Rents component of CPI shelter shows a similar lag, a long way behind the Zillow rent index which is up 14.8% over the 12 months to June.

CPI: Rent

Wages & consumer expectations

Consumer expectations for inflation were unchanged, at 5.3% in June.

University of Michigan: Inflation Expectations

While average hourly wage rates moderated slightly, growing 6.2% in the 12 months to July.

Average Hourly Earnings

Upward pressure on wages is likely to continue for as long as job openings exceed unemployment, with a current shortfall of 5 million workers.

Job Openings & Unemployment (U3)

The Fed

The real Fed funds rate (FFR adjusted for CPI) rose to a weak -6.0% after the latest rate hike, still lower than any previous trough in the past sixty years. Real FFR (red below) should be positive when unemployment (blue) is below 5%. Past lows, circled on the chart below, were in response to high unemployment — when the economy had spare capacity. We now have the opposite, with a tight labor market, and negative real rates are likely to give rise to high inflation.

Unemployment (U3) & Fed Funds Rate - CPI

Conclusion

Some are calling this “peak inflation” but the decline in CPI growth is due to a large monthly drop in energy prices. Food and shelter costs are still rising.

The energy crisis is not over, with Winter approaching in Europe while gas storage levels are at record lows and Russia is restricting pipeline flows in an attempt to create division within the European Union. Energy prices are likely to remain volatile.

The Fed is way behind the curve, with a real Fed funds rate of -6.0%. We expect them to continue hiking interest rates despite the recent fall in energy prices.

According to Larry Summers and Olivier Blanchard, the Fed will only be able to bring inflation down when unemployment is well above 5%. The danger is if the Fed is forced to halt rate hikes before it has tamed underlying inflation. We are then likely to end up with both low growth and high inflation.

Our strategy remains defensive: overweight Gold, critical materials, defensive stocks which enjoy strong pricing power, and cash.

Acknowledgements

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No soft landing

10-Year Treasury yields have climbed in response to the December FOMC minutes which suggest a faster taper of QE purchases and faster rate hikes. Breakout above 1.75% would offer a medium-term target of 2.3% (projecting the trough of 1.2% above resistance at 1.75%).

10-Year Treasury Yield

The Dollar Index retreated below short-term support at 96, warning of a correction despite rising LT yields.

Dollar Index

Do the latest FOMC minutes mean that the Fed is serious about fighting inflation? The short answer: NO. If they were serious, they would not taper but halt Treasury and MBS purchases. Instead of discussing rate hikes later in the year, they would hike rates now. The Fed are trying to slow the economy by talking rather than doing — and will be largely ignored until they slam on the brakes.

Average hourly earnings growth — 5.8% for the 2021 calendar year — is likely to remain high.

Hourly Wage Rate

A widening labor shortage — with job openings exceeding total unemployment by more than 4 million — is likely to drive wages even higher, eating into profit margins.

Job Openings & Unemployment

The S&P 500 continues to climb without any significant corrections over the past 18 months.

S&P 500

Rising earnings have lowered the expected December 2020 PE ratio (of highest trailing earnings) for the S&P 500 to a still-high 24.56.

S&P 500/Highest Trailing Earnings (PEmax)

But wide profit margins from supply chain shortages are unsustainable in the long-term and are likely to reverse, creating a headwind for stocks.

Warren Buffett’s long-term indicator of market value avoids fluctuating profit margins by comparing market cap to GDP as a surrogate for LT earnings. The ratio is at an extreme 2.7 (Q3 2020), having doubled since the Fed stated to expand its balance sheet (QE) after the 2008 global financial crisis.

Market Cap/GDP

Stock prices only adjust to fundamental values in the long-term. In the short-term, prices are driven by ebbs and flows of liquidity.

We are still witnessing a spectacular rise in the M2 money stock in relation to GDP, caused by Fed QE. The rise is only likely to halt when the taper ends in March 2022 — but there is no date yet set for quantitative tightening (QT) which would reverse the flow.

M2/GDP

Gold continues to range between $1725 and $1830 per ounce with no sign of a breakout.

Spot Gold

Conclusion

Expect a turbulent year ahead, driven by the pandemic, geopolitics, and Fed monetary policy. Rising inflation continues to be a major threat and we maintain our overweight positions in Gold and defensive stocks. A soft landing is unlikely — the Fed could easily lose control  — and we are underweight highly-priced growth stocks and cyclicals, while avoiding bonds completely.

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Retail sales, missing workers and the inflation threat

The October labor report shows hours worked were roughly unchanged from September and still 100K below the pre-pandemic high (5.25m). But GDP of 19.5 trillion is up slightly when compared to 19.2T in Q3 2019, indicating that productivity has improved.

Real GDP & Hours Worked

Monthly retail sales for September, on the other hand, were way above trend.

Retail Sales

People are spending Dollars they didn’t earn, courtesy of record government stimulus.

That is one of the primary causes of rising consumer prices (red below): when demand outstrips supply.

Average Hourly Earnings & CPI

A rising CPI in turn causes second run inflation through higher wage demands (green and gray above) if central banks fail to act quickly. They become embedded and difficult to dislodge.

The combined effect of the pandemic and government stimulus has had a profound impact on the US labor market. The economy added 5.8 million jobs in the 10 months to October, at an average of 580K per month. That rate is likely to slow as the economy reopens and enhanced unemployment benefits end.

We are missing 4.2 million employees, compared to the pre-pandemic peak of 152.5m jobs, and seem unlikely to find them, judging by the 10.4 million job openings in September. High levels of job openings are likely to exert continuing upward pressure on wages.

Non-farm Payroll & Job Openings

The missing workers — aided by government handouts — have either retired, quit their jobs to day-trade Tesla and crypto-currencies, or have re-assessed their work-life priorities. No doubt there will be a trickle back to the workforce — as day-traders encounter reversion to the mean and/or savings run low — but the Fed needs to reassess its full employment target. Failure to do so would leave interest rates too low for too long and allow second run inflation to become entrenched. The only way to then dislodge it is with the kind of drastic measures that Paul Volcker used in the early eighties, with the fed funds rate peaking at 20%.

Fed Funds Rate under Paul Volcker

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Job openings flag upward pressure on wages

Job openings fell by 660k in August, from 11.10 million to 10.44 million. Unemployment fell by less, from 8.70 million to 8.38 million (-320k), as absentees return to the workforce. Unemployment declined steeply (-710k) to 7.67 million in September and we expect an even larger decline in job openings as more return to the workforce.

Job Openings & Average Hourly Wage Rates

Job openings in August exceed unemployment by 2.06 million. While this is expected to reduce over the next few months, as stragglers return to the workforce, the persistent gap is likely to add upward pressure to wages. Average hourly earnings growth, currently at 4.6% YoY, is expected to rise in the months ahead.

Small Business - Difficulty in Finding Workers

The number of people who quit jobs voluntarily – to work for another company that offered higher wages and benefits and a signing bonus; to change careers entirely; to stay home and take care of the kids; to spend more time with their money; or whatever – spiked by another 242,000 people to a record of 4.27 million in August, up 19% from August 2019…….This enormous number of quits is the hallmark of a tight and competitive labor market that encourages workers to switch jobs to seek the greener grass on the other side of the fence. (Wolf Richter)

Job Quits

Conclusion

The economy is recovering but the persistent gap between job openings and unemployment suggests that upward pressure on wages is likely to continue into next year. Rising wage rates add pressure on prices of consumer goods and services, adding to the inflationary spiral.

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