What’s concerning about all US labor market data besides today's wage number

If there's one point most investors should agree on, it is that inflation has been running soft on a range of measures for the past two months. Before Friday’s US payrolls report , US core CPI had surprised to the downside for two consecutive months. Today wage gains undershot expectations by 0.4% (4.6% vs 5% expected), which is a very large miss by the standards of this indicator. No surprise, then, that Bonds have been rallying intermittently since November; that the trade-weighted dollar is down about 5% from its peak; and that Gold is making a new 6-month high over $1860/oz.

These parts of Fixed Income are where the simple story ends. As long as one is reasonably convinced that inflation has slowed enough to keep the Fed from hiking beyond 5%, the following baseline should emerge in 2023: (1) Bonds outperform Cash as the market prices Fed rate cuts in 2024 and 2025; and (2) the loss of interest rate momentum undermines a very expensive dollar (chart 1) on some crosses like EUR, JPY and high-yield Latam; and (3) lower real yields boost the Gold price. Whether the economy lands hard or lands soft will impact the magnitude of returns on Treasuries, these non-USD currencies and Gold, but not the sign of those returns. Such is the gift of a Fed soon-to-be on hold, even if Fed beneficence won’t extend to all asset classes unless other conditions hold.

Chart 1: As it often does before and during recessions, DXY has been trading expensive to rate differentials for about 6 months. DXY versus US minus rest-of-world 10Y rate differentials (using DXY weights). Source: Federal Reserve, YCharts.

The reason a Fed pause isn’t sufficient justification for owning almost anything ?is that soft versus hard landing baselines carry dramatically opposite consequences for corporate earnings and therefore for credit spreads and equity multiples. Demand for Commodities ex Gold also craters in a recession, and the only sector that ever manages to deliver coordinated supply cuts (Oil, not Base Metals), usually cannot deliver cuts large enough to prevent an initial downdraft in prices.

Regular readers of these articles know that I have been in the hard-ish landing camp since about mid-2022, because the broad sweep of macro data pointed to a labor market too strong to self-correct. A Fed-induced recession seemed the only antidote, which meant more of the analytic energy should be ?spent forecasting recession length and depth, and linking those features to the required risk premium across Equities and FICC.

?I’m still in the hard-ish landing camp after today’s payrolls report. By that statement, I mean an economic and market baseline with these outcomes: (1) the Fed will need to deliver a contraction in the economy that persists for perhaps three quarters; (2) the unemployment rate will need to rise a couple of percentage points; (3) Equities will probably experience their typical 30% peak-to-trough decline (from the Jan 2022 highs); (4) HY Yield spreads should widen at least 300bp; and (5) Brent crude should test $70/bbl.

There are good reasons to question the durably softer US wage growth, if one widens the data lens to the past 48 hours. Wednesday’s JOLTS report showed the number of job openings remained extraordinarily high at 10mn, while the ratio of quits to hires hit a new cycle high. Yessterday’s weekly jobless claims printed near 200k, which is far from soft. And today’s payrolls report showed a downtick in unemployment to a 60-year low of 3.5%. All things considered, the US labor market still looks very imbalanced, and causal links that generated recent wage softness are not very clear.

For the wage problem to be self-correcting, labor demand need to slow without collapsing (claims at 250k and monthly payrolls under 100k), and/or labor supply needs to rise materially (several percentage point increase in the participation rate). Because none of these background dynamics are unfolding, I am sceptical that today’s downside surprise on wage growth will persist, and that gains in Equities, low-grade Credit and Oil will be sustained.

Links to recent articles on global macro strategy

What the last 100 years has to do with the next 12 months: Risk premia, mean reversion and 2023 return forecasts (Jan 3, 2023)

Late-2022 volatility compression, yesterday’s Fed realism and 2023’s labor market reckoning (Dec 15, 2022)

The Fed’s next moves are obvious, but 2023 remains a duration play (Dec 5, 2022)

China's COVID protests and the super-short Commodities supercycle (Nov 28, 2022)

Further evidence that 10Y bond yields have peaked, and what that path means for other markets (Nov 11, 2022)

Bonds are worth owning, even after yesterday’s strong US?CPI report (Oct 14, 2022)

Can?Emerging Markets ever be more than a tactical asset class? (Oct 10, 2022)

What to do with the second-strongest US dollar?ever (Sep 30, 2022)