January 17th 2023
Those investors who are hanging on to the hopes of an imminent Powell Pivot back to ZIRP and QE received some disappointing news from the latest Non-farm Payroll Report. During the month of December, 223k net new jobs were created, and the unemployment rate fell to 3.5% from 3.6%. That 3.5% unemployment rate ties the record low of data going back 50 years.
It turns out that 2022 was the 2nd best year of job growth in history. However, the headline figures belie the true weakness of the labor market. December’s job gains were the lowest in the past two years. Most importantly, the number that few people talk about, but is probably the most important, is aggregate hours worked. This index measures the quality of employment (either part-time or full). It shows total hours worked actually shrank last month; and it was the second such decline in a row. Meaning, the number of productive hours in the economy is shrinking despite the increase in net new jobs. People are losing a full-time job and replacing them with two or more inferior jobs.
To this point, the NFIB Small Business Optimism index recorded its 2nd weakest reading since 2013. Small business optimism declined 2.1 points in December to 89.8, marking the 12th consecutive month below the 49-year average of 98. Since small business accounts for 64% of all new jobs created, according to the SBA, it would be hard to see how the US economy could have a very healthy labor market when nearly 2/3rds of it is dysfunctional.
But there just isn’t the excess labor to shed heading into this deep recession. Hence, the labor market economists that haunt the fed will be reluctant to supply Wall Street with the required easy money policies to engender the usual economic and market rebound because they focus so much of their attention on the unemployment rate.
In sharp contrast to the headline data produced by the BLS, let’s take a deep dive into the ISM services Index for December. The employment index dropped into contraction territory from expansion in November, from 51.5 to 49.8. Hence, the largest part of the US economy is cutting jobs, according to this ISM survey, not hiring hundreds of thousands of new people. And this survey also shows that the overall Services Sector is in contraction as well, plunging to 49.6 from 56.5. This was the first contraction in the Headline Services Sector in the past 30 months. What is most interesting in this report is that the floor fell out of the new orders component, cascading from growth in November at 56 to contraction at 45.2! That is a 10.8 percentage point plunge in new orders! Any reading below 50 means the index is contracting. By the way, the ISM Manufacturing Index in December also contracted to 48.4, with the new orders component falling to 45.2 from 47.2. Meaning both sectors of the US economy are now shrinking.
But again, for those who feel a fed pivot is right around the corner, the ISM prices paid index came in at 67.6 in December vs.70 in November. While this means prices are rising at a slower pace, they are still rising quite rapidly. Remember, a reading of 50 would indicate stable prices. So, 67.6 is still much too fast for the fed to stop hiking rates, much less start cutting rates. But Wall Street lemmings are infatuated with weak data, and so, they really became overly ebullient with the news that the largest part of the economy is now contracting. The major averages soared over 2% on the day we learned that the economy was now blatantly falling apart.
However, this is exactly the Pavlovian behavior that Jerome Powell is seeking to break. Our central bank’s reflex is to infuse the economy with a massive amount of new money at the first whiff of every recession. This is what caused the market to lose faith in the dollar’s purchasing power in the first place. That playbook had worked well since the crash of 1987, all the way to the COVID pandemic in 2020. This is because inflation had been dead and buried thanks to the work of Paul Volcker and the credibility he regained on behalf of our central bank. Unfortunately, after decades of abusive fiscal and monetary largess, that faith in our central bank has been lost. Hence, Wall Street continues to underestimate Powell’s determination to disabuse the market of its mistaken belief that the Fed will automatically pave over every economic and stock market pothole.
Now, please understand I’m not saying the Fed will never pivot back to QE and ZIRP. It will indeed. However, that decision will come much later and with much more trepidation than what Wall Street is expecting. It will probably come after one of the following conditions occurs: the credit markets freeze, shadow banks begin to file for bankruptcy, the major averages drop by 45-50% from their peak, core PCE inflation falls to 2%, or we have two back-to-back negative non-farm payroll reports. Until then, it is the notion of a perpetual fed put that Powell needs to end.
Therefore, there should be a 5% Fed Funds Rate by March; and then the FOMC will seek to hold it there for as long as possible–some members have stated it will remain there well into 2024. That means rates will have been raised by 500 bps in one year after being below 1% for ten of the last fourteen years. Such a situation has never happened before…nothing even close. These lagged monetary effects, along with massive QT, will hit the economy hard this year. The bottom line is this: the economy is now shrinking, and the Fed is still hiking rates and reducing the money supply. And, it will not be easing monetary policy any time soon, not with CPI at more than 3x the Fed’s target.
The reopening of China is providing yet another excuse for a short-term bounce in the market. Nevertheless, the joke is on the perma-bulls, who believe this is now a green light for a new bull market to begin, even though valuations are absurdly high and earnings are about to suffer a significant decline.