Today’s job report shows private payrolls growing at a healthy 2 percent annual rate. It also shows average hourly earnings growing at an 8.5 percent annual rate. The Federal Reserve Bank (Fed) has to be concerned about soaring wage growth and its implications for inflation.
The Week That Was
Today’s employment report shows November’s private payrolls, increased by 221,000, a 2 percent annualized rate. Average hourly earnings were up by 8.5 percent, up from 6 percent. The acceleration in earnings increases indicates the Fed has a long way to go in containing inflation.
Yesterday’s report on October income and spending shows no indication of any slowdown in
spending, wages, or real growth.
The good news on inflation was countered by bad news on spending. Spending and wages continued to grow at annual rates of 6 percent to 9 percent at the beginning of the fourth quarter. When demand grows this rapidly, future inflation will remain well above the Fed’s inflation target.
In contrast to October’s signals of strong demand, two business surveys (ISM and S&P) show U.S. November manufacturing activity and new orders declining. The ISM new orders component was 47, the third consecutive month it has been below the break-even level of 50. An alternate S&P PMI manufacturing survey also reported a decline in output and new orders.
Since manufacturing accounts for about 10 percent of the economy, the overall economy still can grow.
Weekly unemployment reports continue to show the first hint of a softening in labor markets. Insured unemployment payments rose to 1.6 million, the highest payment level since April. Initial unemployment claims held up better. The average for the four weeks ending November 26 was only slightly above the 200,000 to 250,000 range of the past seven months.
Things to Come
On Monday, both business surveys (ISM, S&P) will report on November service sector activity, which represents 70 percent of the economy. That means Monday’s reports will be significant.
The ISM report for October showed the service sector remained strong, with readings in the mid-50s. In contrast, the alternative S&P advanced survey for November shows services sharply declining, with a reading of 46.
Although there are some signs confirming our expectations of slower growth, there are other signs pointing toward strength. The latest Atlanta Fed estimate of fourth quarter real growth remains close to a 3 percent annual rate. This estimate is subject to change depending on upcoming data.
Money, Money, Money
Monetary data show the Fed sold $280 billion in securities since June. Banks have offset these sales by reducing their deposits with the Fed by $109 billion. Hence, there has been a net decrease of $171 billion in money entering the economy.
This decrease represents the extent of the Fed’s tightening. It was sufficient to bring the six-month rate of growth in money to a -1 percent annual rate and bring the year-over-year change to 26 percent.
The Fed says it intends to continue to drain funds from the economy. The question is how much the upcoming policy moves will reduce next year’s spending? ALthough no one knows for certain, the normal six to nine month lag points to the main impact occurring in the first half of next year. We continue to expect spending to slow enough to plunge the economy into a recession.
Market Forces
Both stocks and bonds rallied as markets anticipated the Fed will be successful at bringing
down inflation with only a limited downturn in the economy.
The best news: October’s consumer core inflation measure rose at a 2.7 percent annual rate. Financial markets are convinced the Fed’s governors will succeed in containing inflation.
The spread between the yield on 10-year Notes and inflation-adjusted 10-year Notes indicates financial markets expect the inflation rate over the next decade to average close to 2.25 percent.
We all hope the Fed will succeed in bringing about a relatively soft landing with low inflation. Although success is possible, we doubt the Fed will pull it off. The weakness in productivity and the collapse in housing activity continue to point to an extended
period of weakness ahead.
To succeed, the Fed will probably have to keep draining money from the economy while expecting the stock market and the nation’s businesses to continue as if nothing were happening.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 28 percent
Monetary Policy: restrictive
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