Is A Soft Landing in the Offing?

By Dr. Charles Lieberman, Co-Founder & Chief Investment Officer

Hiring has slowed, but it is yet to be determined if it has moderated enough or for the right reasons.  If hiring is weaker because firms can’t find the right workers to hire, wage inflation will continue.  The slight slowing of average hourly earnings to 0.2% in October is very good news indeed, but one month doesn’t constitute a trend.  So, I’m just not ready to buy into the thesis that the Fed is close to accomplishing its 2% objective quite yet.

No doubt, job growth has slowed.  After some months of 400,000 or more new hires, we’re down to 243,000 per month over the past year, 204,000 over the past three months, and just 150,000 in October.  But how much of this deceleration is due to reduced demand for labor versus an inability of firms to find workers to hire?  Slower payroll gains in response to weaker economic growth is precisely how the Fed hopes to contain inflation.  But can we ignore the 4.9% surge in Q3 GDP?  Or, is hiring slowing because firms simply cannot find workers to hire?  Job Openings data have rebounded and remain historically very high.  And the labor market remains very tight, a fact fully appreciated by union leaders, who are pressing their case for large wage increases and getting them.  According to Bloomberg Law, average first year wage increases in 2023 are running close to 7%, excluding one-time payments, the highest in decades.

The answer to my question will be revealed by the behavior of wages.  Weaker final demand will slow the pace of hiring and reduce wage inflation.  But if hiring has slowed because workers remain scarce, wage inflation will remain stubbornly high, as firms compete to employ the few workers available.  There’s no clear answer, as yet.  Average hourly earnings did moderate from 0.3% month over month to 0.2% in October and 4.1% year over year.  That got the stock and bond market extremely excited and both rallied sharply.  But the more accurate Employment Cost Index shows an uptick from 1.0% to 1.1% in the most recent quarter, while total labor costs rose 4.3% over the past 12 months and wages and salaries held at 4.6%.  These wage increases are incompatible with a moderation in inflation to 2%, the Fed’s target.  Moreover, at 150,000 in the latest month, hiring is still a bit strong.  It is downright dangerous to focus on numbers that support your economic aspirations and ignore ones that contradict them.  And it is especially risky to do when the latest numbers are distorted by strikes that produce temporary economic headwinds.

Despite my reservations about jumping to premature conclusions, the Fed and the market reacted appropriately to the latest data.  Bond investors had previously piled on board to the idea that long-term interest rates were too low.  We have long held the view that rates were unsustainably low, especially longer-term rates.  Growth was solid, inflation wasn’t moderating very quickly, the budget deficit remains out of control so government financing needs remain elevated, and real yields on bonds were far from adequate to reward investors for the risk being taken.  So, rates surged, which should not have been a total surprise.  But as is common in markets, people jumped on board and the bond decline became a rout.  And at the first inkling of good news that slower growth might tame inflation, rates plummeted.  Manic depressives always behave that way.  Don’t get caught up in the hysteria.  Investors need to focus on the longer term.

Fed policy is likely to keep rates higher for longer, because it will take some time to squeeze inflation out of the system.  Some progress has been made, so the Fed can afford to wait a bit to see if they will get to their 2% target.  I’m comfortable with the Fed’s decision to pause policy.  But I’m less optimistic than the market.  I’m also dubious that 10-year Treasury rates will be sustainable at 4.5%.  In the short-term, the slower pace of growth implied by the employment report and the surge in bond prices resulted in a reasonable, strong stock market bounce, especially for the more interest rate sensitive sectors within the market, like housing, utilities, REITs, and financials.  Safe havens, like consumer staples and health care, lagged.

It also remains premature to judge if the Fed is going to get the soft landing it is hoping for.  It may take months, possibly even quarters, to answer the question of whether we will have a soft or hard landing.  Near term, I still expect solid growth to continue.  But the good news is that it will take time for that question to be answered, so investors can refocus on the recovery taking place in corporate profits and don’t need to be quite so concerned about surging interest rates, at least for now.  This makes me hopeful for a rise in stock prices into the end of the year and a somewhat less volatile bond market.

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