Powell and payrolls revive rate cut hopes
Chairman Powell played Captain Sensible on Wednesday, doing just enough to keep rate cut hopes alive. First and most importantly he pushed back against talk that rates might actually need to go up at some point, while acknowledging that recent inflation prints have been disappointing so that the Fed would need more time to get confident about getting back to target. Second, he still believes that the labour market is softening and that inflation is likely to bump down closer to target in due course. And third, he said that strong economic data wouldn’t be a problem in itself if it continues to reflect improving supply trends (labour force growth, productivity). That's pretty much our read on the data as well, (see previous post) and if correct it means that renewed rate hikes are very unlikely and rate cuts for this year are still in the frame. Which is how markets parsed his press conference too.
Today’s Employment report added plenty of fuel to the fire. Most eye catching of all was the drop in average hourly earnings to 3.9% yoy. Unemployment has risen just 0.5% from its cycle low but Average Hourly Earnings are down from a peak of 7.4% in January 2022. (AHE for all private employees are down from 6.3% to 3.3%). The broader quarterly measure of employment costs (including benefits) retreated to 4.2% in Q1:2024, meaning that unit labour costs were up just 1.8% yoy. Since unit labour costs are the best single guide/short-leading indicator for underlying inflation that's very encouraging.
Meanwhile, job openings have continued their downward trend (down 5% in Q1), while non-farm employment growth was soft in April (150,000 if you include revisions to previous months) after growing at robust 1.8% per year in Q1:2024. Particular strength in employment gains were seen in trade/transportation and education and health care. Perhaps not co-incidentally, these are the sectors seeing the biggest price increases in both the CPI and the PCE. Essentially, it looks like the mismatch between supply and demand post-covid has mostly unwound, except in a few sectors which are having an outsized impact on measured inflation.
All in all wage growth in April and unit labour cost growth in Q1 are pretty good reasons for the Fed to feel comfortable, though maybe not quite confident, that inflation is heading in the right direction. And consistent with other evidence that the labour market is almost back to "normal". Markets celebrated in some style, with big gains for bonds and equities.
Only a few days ago we were peering into the potential abyss of another big sell-off in bonds and significant multiple compression in stocks, which actually helped to set up the conditions for today's squeeze higher in asset prices. (Option markets were pricing the potential for an unusually big move up or down going into the Employment Report). And given how data dependent the Fed is there is still room for another shift in mood if April's CPI report disappoints again. Like Captain sensible, we think the underlying trend for core inflation is still downward, but that doesn't guarantee us against another bit of bad karma later this month. Plus there are other reasons to worry about bonds about which more in coming days.
Comments