Markets: It’s Inflation Week

  • November 9, 2021

Week in Review

November 1–7

I love it when a plan comes together…

Jerome Powell and his friends at the Federal Reserve stayed true to script on Wednesday when they announced a $15b-per-month tapering of bond purchases that aligned almost perfectly with what the market expected[1]. The Fed also continued to get high marks for communication by sufficiently distancing the taper from any proposed increase in interest rates, which allowed markets to do, well, not much of anything in response.

While Powell only committed to two months of easing at that pace, he heavily implied that the tapering would continue unless something pretty surprising happens between now and the middle of next year. Candidates for such a surprise could include runaway inflation or a sudden acceleration of progress on the jobs front on one hand, or a dramatic surge of new COVID cases and/or a massive disruption in capital markets on the other. But barring any of that nonsense, we should be done talking about quantitative easing by around June of next year.

The job market also followed its cues exceedingly well by turning in an increase in payrolls of 531,000 – almost smack-dab in the middle of economists’ forecast range[2]. Last month’s total was revised up pretty substantially, too, keeping the Fed honest when it tells the world that the U.S. jobs market is recovering adequately but still has room to grow before the fed can dust off its hands and consider the job finished.

It’s notable, too, that Friday’s payroll report continued to show the jobs recovery broadening out a little bit: leisure and hospitality jobs continued to make up a substantial percentage of jobs created last month, but other areas like manufacturing, education and construction are contributing too, which suggests that there may be more to expanding payrolls that simply a post-COVID return to work for bartenders, travel agents and restaurateurs.

That said, it wasn’t all good news within the jobs report as things like the average number of hours worked and the overall participation rate actually underperformed expectations by a little bit. Average hourly earnings continued to rise, too, and are now up 4.9% year-over-year. And looking a little bit farther afield to Thursday’s layoff report from Challenger Gray and Christmas[3], the number of layoffs ticked ever-so-slightly higher in October after remaining at historically low levels for the year-to-date period.

The real eyebrow-raiser in that report, though, was word that just over one-fifth of October’s layoffs were related to a refusal among the laid-off to get the COVID vaccine. That observation also took on a slightly more ominous tone this week when the Biden administration announced that OSHA would soon require any U.S. employer with more than 100 employees to require staffers to get vaccinated or submit to COVID testing every week[4]. That mandate was quickly and at least temporarily blocked by the court, but if ultimately allowed to stand the number of vaccine-related firings seems likely to go up. These small warts on an otherwise strong showing for the jobs market last week are all forgivable though, and you’d be hard pressed to find someone who wasn’t at least a little impressed by Friday’s report.

A few developments on the policy front are worth mentioning, starting with what one cheeky observer described as “a stunning piece of inaction” by the Bank of England when it defied market expectations and decided to leave rates alone[5]. Analysts had come around to the idea that the BoE would be among the first major central banks to boost rates in response to spiking inflation, and when it didn’t, bonds there rallied (as did government bonds in a few other markets as well.) So much for using the UK as a window into what might lie ahead for U.S. markets when the Fed gets around to raising rates sometime during the lifespan of my great-great-grandchildren…

Closer to home, the so-called bi-partisan infrastructure bill – that’s the skinny one that Senators passed months ago and includes around half a trillion dollars in spending for things like roads, rails and power grids – passed the House and is on its way down Pennsylvania Avenue for President Biden’s signature. Less certain, though, is the fate of the much larger, $1.75t Build Back Better Act that is quickly becoming Biden’s signature legislative priority (or his Alamo, depending on how you view its prospects and the electorate’s likely reaction to it.) That bill made progress in the House last week as well but still faces significant opposition and at least one more vote in the House before it goes to the Senate, where the chances of passing are even more dicey.

And in the background to all this, don’t forget that there’s still another debt ceiling debate looming for early December, by which time the economy will have ambled far enough down the road to reach the can that our esteemed congresspeople kicked down the road last month. Whether markets will pay more attention to this debt ceiling debate and potential default on U.S. debt than they did the last one (or whether they are well and truly hardened to it after so many can-kickings before it,) remains an open debate. But with so many interesting policy debates going on that might (or might not) allow the stimulus/support baton to be passed from a monetary runner to a fiscal one, I felt compelled to at least issue that reminder.

And now we’ve reached the portion of this weekly write-up where we discuss the odds-and-ends: all the stuff that happened last week that is potentially just as important to the markets and economy as what I’ve discussed above but is way less fun to write about. At the top of the list from last week is the full slate of Institute for Supply Management (ISM) and Purchasing Managers Index (PMI) data which showed – predictably – that the US economy is still in the throes of a supply chain smash-up of historic proportions. Backlogs on the services side showed their fastest increase ever as a result of still-robust demand even amid labor, materials and supply chain shortages that showed no signs of relenting[6]. And you could almost hear the manufacturing sector gasp out a frustrated “yeah, me too…” even though the acceleration in new order activity there shifted into a lower gear for goods producers[7]. And that brings up a good point: at some point, all these supply chain stresses and price woes might cause optimism in general to wane. And when that happens, PMIs will probably start to soften, which could in turn usher in a new (and perhaps less-friendly) era for capital markets.

What to Watch This Week

November 8–14

Notable economic events (November 8-12)

Monday: U.S. travel restrictions lifted

Tuesday: NFIB small business optimism, Producer prices (PPI)

Wednesday: Consumer prices (CPI), weekly jobless claims

Thursday: Veteran’s Day (bond market closed, equity market open)

Friday: UofM consumer sentiment, JOLTS

It’s inflation week. Producer prices will show exactly how much more expensive things have become for the productive side of the economy on Tuesday when the Bureau of Labor Statistics reports the producer price index (or PPI) for October. Meanwhile, consumers will get their dose of bad news on Wednesday when the CPI (consumer price index) is released.

It would be unwise to completely downplay the significance of either of these reports, but it’s also worth pointing out that it would probably take a surprise of monumental proportions to move the needle much. That’s because investors are well aware that prices are rising sharply but have convinced themselves that the Fed’s take about transitory nature of inflation is the correct one. As a result, markets have become at least partially hardened against almost anything inflation-related except perhaps a shockingly bad reading. I wouldn’t expect either of this week’s reports to qualify.

Moreover, consumers are also taking higher prices mostly in stride – at least for now. We’ll get another opportunity to test that sentiment on Friday, when the University of Michigan releases its mid-month read of consumer sentiment. For months, the good professors at the UofM have been watching closely to see whether a damaging “inflationary psychology” has begun to emerge among U.S. consumers that might spark a self-reinforcing inflationary spiral like the one that fed inflation during the 1970s. That hasn’t happened so far, which has given some credence to the equity market’s apparent “we’ll calmly march forward while we wait it out” attitude with regard to inflation. Of more immediate concern though would be any evidence that suggests consumers are becoming less optimistic in general as rising prices, lingering disconnects in the labor market or any other features of the post-pandemic economy pressure their psyche. If there’s anything consequential in Friday’s report, it’s more likely to be that than sudden evidence of a self-igniting inflationary spiral.

Speaking of sentiment indicators, Tuesday’s business sentiment report from the National Federation of Independent Business will represent the latest opportunity to assess how small businesses are coping with rising prices, supply chain stress and the still-wonky labor market. Like consumers, small businesses have become increasingly worried about how these trends will influence future economic performance even if inflation begins to burn itself out in the near future. In my view, the NFIB’s survey is one of the best ways to assess future business confidence given that smaller firms are likely to feel the pinch from a slowing economic environment than larger, more established enterprises.

On the policy side, we should probably expect more headlines surrounding the advance of the various infrastructure spending bills this week, with the smaller, bi-partisan bill possibly even crossing the goal line even if the massive Build Back Better Act continues to dodge and weave its way through the process like Javonte Williams shredding the Dallas secondary. Of more immediate interest, it’s notable that as of Monday, the State Department eased travel restrictions for a large portion of international destinations including Canada, Mexico and Europe. Vaccinated travelers will no longer have to provide negative test results before entering the U.S., which has already had a positive impact on international bookings. I also wouldn’t be surprised to see some discussion of whether or not the White House will re-nominate Chairman Powell for the Fed chairmanship – something the market is paying very close attention to.

Finally, Friday’s JOLTS report (a detailed look at the number of job openings in the U.S. as well as information about who’s quitting their job for greener pastures) will provide the latest window into the ongoing recovery in the U.S. labor market. Last month’s JOLTS report showed a record-high number of U.S. workers who quit their jobs in August, which is commonly seen as a sign of confidence among workers. That number is likely to get attention again this month when September’s data is released.

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[5] Bloomberg, 11/4/21