You don’t get stagflation without stagnation


Outlook: A 180-degree shift in sentiment from gloom to ‘everything is fine, Jack’ stems from payrolls at a hefty 467,000 gain instead of a 301,000 loss as ADP had forecast for the private sector (and the expected gain of 150,000 at Bloomberg just before the release).

Prior to Friday’s NFP release, some had tried to say the data wouldn’t mean anything, anyway, due to so many short-term, Omicron-led factors. Some have tried to say that Friday’s numbers only show that the jobs data, all the jobs data, has always been wrong. We agree that labor market data is always wrong and generally misleading, but mainly because it does not take into account the gigantic gray market and due to stupid data collection methodology (firms and households). No one is encouraged to make an accurate report.

But getting the direction wrong this time and blaming all the numbers all the time isn’t enough to convince if we believe errors and miscounts are systematic. In other words, Friday’s figure may be as wrong as the previous data but in the same way and to the same extent. The new data is “correct” in the sense that there is robustness in the labor market and therefore in the economy as a whole, and does not take into account the new seasonal adjustments. There is no stagflation without stagnation.

Add to the state of the labor market two key factors: the pandemic is fading, and even though it is fading unevenly, people are fed up with the eyes of the rigor and staying at home. Rightly or wrongly from a public health perspective, people want to get back to work.

Second, a year-end survey found that 8.8 million people (The Economist) weren’t working because they had Covid or were caring for someone with Covid (many of them women with the problem child care amid controversy over schools). Bloomberg has a count of 3.5 million. Be that as it may, the labor pool that will soon be available is vast. If, indeed, Covid goes away and schools stay open, the payroll could well provide half a million jobs per month for the next 6-12 months. It never happens, but it could happen.

About that inflation data due Thursday: just about everyone thinks it will be at least 7% or maybe a little higher. This should keep yields high and justify the Fed’s hike plan. But what about balance sheet contraction?

We are hesitant to enter the fray because, like just about every other economist on the planet, we don’t understand the dynamics, but the timing and magnitude of the QT (contraction of central bank balance sheets) has an unknown effect on returns. The BoE said it would stop reinvestments when the discount rate reached 0.50%, reached last week. Earlier, Japan stopped adding to the BoJ treasury and reduced its holdings in September and December. The ECB says it is allowing buying to fade on the same schedule as before.

The United States, of course, has the biggest amount to pour. Logically, the central bank recovering all assets should depress yields. But a report cited in The Economist by TS Lombard finds that yields are much more strongly correlated to inflation expectations than to QE. If QE fails to move the bond premium, QT should not have much effect either.

This goes directly against the general belief that QT will raise rates on its own, a view the Fed itself shares. Lombard’s history indicates that the only effect QT has is to signal future interest rate decisions. But note that the Fed continues to try to put QT in the background and is ambiguous as to what it thinks the effect of QT is or should be on interest rates. One thing we can expect – QT is not a substitute for increasing rates. More QT shouldn’t mean fewer rate hikes, causing bond yields to fall, making QT “oddly, a source of stimulus – the last thing a central banker with an inflation problem should want.”

It’s understood? We must have read it three times. And we don’t buy it, at least not entirely. The stock market sees QE as a source of free/cheap money to speculate with. QT takes money out of the banks and, with the increase in the fed funds rate, increases the cost of margin. As we showed last week, the US stock market has always been driven by margin and today’s bubble, if we want to call it that, is not something new. The rising cost of margin should only affect margin traders (economists can joke around too). A marginal margin trader is a trader whose track record really does not stand up to scrutiny.

So, are banks and brokers cutting them off, as they should? Not when there’s a penny or two more to be made. We used to call brokers “pond scum” and the charge has hung around the internet for years, now overtaken by others using the same words. When you make a living a penny (or part of a penny) at a time, you have an incentive to offer a margin. Period. This idea casts a shadow over the idea of ​​the stock market crash. And yet there’s that P/E, double the historical norm, not to mention a propensity for unequal wild herd behavior, including panic.

As for the QT debate, the implication of the Lombard study is that it may take place in March alongside the first surge or in June as some suggest (“mid-year”), but neither date is correct. need to be monitored. It is inflation expectations, embedded in swap prices and the like, that need to be watched. Here’s a scenario: we get inflation of 7% in February or a bit higher, and the Fed hikes in March. In May it fell to (say) 5-6%, thanks in part to improving supply chains, and the Fed is still making 25 basis points plus a significant QT.

Yields then only reflect the improved outlook for inflation. Nobody really thinks that by the end of the year inflation will be back to the old 2%, but numbers like 2.6% (Fed) and 3.6% (Conference Board) may be found. This is the PCE version, not CPI (which will be higher). The regular version of the CPI in the Atlanta Fed’s one-year business inflation forecast (January 2923) is 3.4%.

If by the June FOMC meeting, inflation is heading towards half the January/February number, this implies that yields are stopping rising and possibly pulling back. We could end up with the actual return still falling short of a positive number. We think that’s a problem. The actual return should be positive. But to get a real return, the current 2-year yield must be above 3.5% and two increases are not enough (1.316 today + 50bp = 1.816%). The 2-year is considered the most sensitive to the rate. Yield seekers will continue to monitor the stock market.

And that is the happy and godly scenario. What happens if inflation persists at high levels like 7% for months? Somewhat oddly, this could allow the Fed to accelerate QT even as those 6 or 7 wacky hikes really materialize. We see jokes from economists about wishing they had become firefighters and got an inflation-adjusted pension, or chasing commodities/gold/land as an inflation hedge. Either way, we won’t get substantial real rates any time soon, leaving the stock market as the only liquid asset class.

There’s no shortage of economists who agree with former TreasSec Summers that inflation is worse than we think and will be more persistent, which means the Fed will have to raise rates by a bigger amount. than what the bond market is currently considering. Former New York Fed Governor Dudley, the liquidity guy, agrees and Richmond Fed Barkin sees a final range of 1.5-1.75% for fed funds, or 6-8 hikes.

Strap on your loins for Thursday’s IPC. Every one of these ideas will be spread and some will throw stones. What this means for the dollar is unclear. We find it very odd that Lagarde does not rule out rate hikes being interpreted as a “pivot to warmongering.” Granted, several European central bankers are casting bait to see who bites, but an ECB hike just isn’t in the cards anytime soon, when it’s a dead certificate in the US. So why is the euro clinging to its gains? It’s a mystery and suggests the Fed hike scenario is fully priced in. Which, three or six? We’ll need more data and more talks with the Fed to find out, but even then the change in the Schatz and the Bund is equal to or greater than the change in their US counterparts, and that may be- be the determining factor. And yet, yields are increasing everywhere, even in Japan. See the chart from TradingEconomics.com. (We could also imagine that the general distaste for American things might have something to do with it, though traders swear it doesn’t.)


This is an excerpt from “The Rockefeller Morning Briefing”, which is much larger (about 10 pages). The Briefing has been published daily for over 25 years and represents experienced analysis and insight. The report offers in-depth information and is not intended to guide FX trading. Rockefeller produces other reports (spot and forward) for trading purposes.

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