By Chuck Lieberman
The economic recovery marches on, although the pace is accelerating once again after the Delta variant recedes from its summer spike. With Covid cases receding, the recovery is back in full bore mode. Hopes had been high that some of the bottlenecks might improve—specifically that labor force participation might increase–ameliorating the upward pressure on inflation. Instead, it now appears that the economy must cope with labor scarcity for the indefinite future, threatening unremitting wage and inflation pressures. The Fed is still clinging to the idea that the inflation pressures will prove transitory and took a baby step towards normalizing policy by beginning to taper its bond buying. That’s an ever more obviously risky bet, given the strength of the labor market. Yet, the bond market has bought into the idea, so interest rates declined after the latest jobs report. Bond investors are likely to regret that judgment.
Friday’s strong jobs report provided yet more definitive evidence that growth is strong. A 531,000 job gain, reinforced by upwards revisions of 235,000 to prior months, a decline in the unemployment rate to 4.6%, and average wage gains of 0.4% for the month (that actually understates the rate of wage inflation) provide a coherent story of rapid economic recovery. While firms are trying to fill 10.4 million job openings by offering higher starting pay and enhanced benefits, a record 4.3 million workers quit their jobs in August, as workers job hop to accept higher paying positions elsewhere. Worker strikes have also picked up, with Deere and Kellogg’s among the latest notable examples. It was widely hoped that labor availability would increase after the extra unemployment benefits expired and schools reopened after Labor Day, so parents could go back to work. Instead, the labor force participation rate remained unchanged over the past several months. The idea that labor availability will increase and that increased supply would temper the upward pressure on wage rates now seems to be wishful thinking.
Inflation concerns are the key behind the Fed’s decision to begin slowing down its bond purchases. The Fed implemented the bond buying when the economy was in freefall due to the pandemic in an all-hands-on-deck effort to stem the decline and promote recovery. That emergency program is well past its sell by date. Even so, the Fed still prefers to drive unemployment lower, so it is cautiously and systematically scaling back this bond buying to end in June of 2022. Proceeding so slowly risks allowing higher inflation to become embedded in the economy. Moreover, the House just passed President Biden’s $1 trillion infrastructure package, which will provide an additional boost to growth. The Build Back Better bill, now seemingly around $1.75 trillion, if passed in some form, would add to the turbocharge. It is hard to envision any slowdown in economic growth in the quarters ahead, which only adds to the inflation risk. Larry Summers, President Obama’s Secretary of the Treasury, has described fiscal policy as the most irresponsible in more than 50 years, since Lyndon Johnson’s Great Society program implemented at the same time as large expenditures were being made on the Vietnam War. That policy combination produced record high inflation and interest rates. We don’t wish to repeat that experience.
The environment we see is one of strong growth, held back only by bottlenecks and scarcities as firms try to expand operations to meet demand. These are textbook conditions for inflation to increase. So, we are very focused on playing the reopening and expansion of the economy with firms that are beneficiaries of inflation. On the fixed income side, we are playing defense, trying to protect against the rise in interest rates that we see as inevitable. We have been positioned this way all year, which has worked well, and the latest data reinforces our confidence that we are well positioned for the described economic environment.
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