Federal Reserve is in a tough spot
News
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Posted 05/12/2022
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Although recent bets have been on a “pivot” to reducing the rate of tightening policy by the Federal Reserve, the last barrier to this was identified as the job market. Friday’s shock NFP report has seen the potential for a return to USD strength as the job market appears to be more resilient than previously thought, pointing to higher inflation continuing to be a problem ahead.
Big NFP data miss
US employers added more jobs than forecast and wages surged by the most in nearly a year, pointing to enduring inflation pressures that boost chances of higher interest rates from the Federal Reserve.
The US jobs report came in as a big shock on Friday, with the median Bloomberg survey of economists calling for a 200,000 jump, but numbers coming in at 263,000 with the participation rate dropping again to 62.1%. This is the 4th monthly decline and leaves us well short of the pre-covid 63.4% level. The unemployment rate held steady at 3.7%.
On top of this the jobs report showed an increase in hourly earnings, sharply higher by 0.6%, bringing wage growth to 5.1% year on year. Even though this is an obvious win for employees, it creates another tricky data point for the Fed to manoeuvre around in their final interest rate decision for 2022.
Powell and the Fed Board
Earlier in the week the US Labour market was highlighted by Powell as a significant barrier to reducing the pace of interest rate rises. He was saying “to be clear, strong wage growth is a good thing,” “but for wage growth to be sustainable, it needs to be consistent with 2 percent inflation.”
In order to do this the job market will need to soften, however this is starting to look less likely with the perfect storm of low immigration, an aging population, a significant skills gap and a declining participation rate that has not shown any signs of reversing.
With the jobs report coming in significantly stronger than expected several economists on Friday commented on what they believe the Federal Reserve’s position may be:
The labour market "remains far too hot for the Fed" ~ James Knightley ING economist
“Stronger-than-expected hiring can buy the Fed more time to stay aggressive" ~ Joe Manimbo, senior market analyst at Convera
“The resurgence of average hourly earnings growth shows labor shortages are still pressuring inflation, pushing back against the idea - supported by a few Fed officials, as indicated in the November FOMC minutes -- that wage growth is cooling fast. Given the slow adjustment in the labor market, Fed officials will likely have to raise their terminal-rate forecast from what they wrote down in the September dot plot.”
~ Anna Wong and Eliza Winger, economists
The aging population and participation rate
By 2034 it is estimated that in the US without changes to immigration policy there will be more people retired than children, as the tail end of the boomer generation leaves the employment market.
In the meantime, the participation rate in the US continues to drop, with routine retirements having removed 1.3 million people from the labour market, but excess retirements taking an additional 2-3.5million from the market partly due to covid impacting these older individuals more. Not only this but the job report also showed a weakening participation rate among those aged 25 to 54. It declined for a third month, led by women.
US immigration policy
Powell recently said “Policies to support labor supply are not the domain of the Fed. Our tools work principally on demand.” “Without advocating any particular policy, however, I will say that policies to support labor force participation could, over time, bring benefits to the workers who join the labor force and support overall economic growth. Such policies would take time to implement and have their effects, however.”
Despite years of discussion immigration remains a hot topic in the US, with Trump’s wall possibly being the most divisive in recent years. The last major immigration reform in the United States happened in 1986 and was signed by then-President Ronald Reagan. With the US midterms putting the US back into a position where the Republicans control the House and the Democrats control the senate this looks unlikely to be fixed anytime soon. So immigration is unlikely to help improve the participation rate.
Job market could be strengthening
In order to get inflation under control in the US Powell and the Fed Board have specifically identified wage growth and the unemployment rate as key factors. There are clear signs though this may not be occurring. For the economy to maintain the current unemployment levels, it only needs to add around 100,000 jobs per month. Average 3-monthly NFP job growth has been around 275,000m well above this level.
LaSallem a US recruitment firm, recently reported 84% of companies it works with are planning to hire in 2023, marking a roughly 20 percentage point climb from the share that was planning to hire in 2022. This is on top of a 50% increase over last year in demand for salespeople. You would generally consider hiring salespeople as a lead indicator of economic growth.
Additionally, in the NFP report job gains were concentrated in a few categories: leisure and hospitality, healthcare and government. Now regarding hospitality the employment levels are still below pre-pandemic levels and have more room to grow, again supporting the job market strength.
What does this mean for gold and silver
The USD rising on the back of the jobs report with silver and gold at first falling and then reversing is a sign of what we might expect ahead. Despite the bad news, they have both continued to rise into the headwind of US economic strength this time around. This is especially true for silver, moving from around $22.60 down to $22.30 after the report, but then settling above $23 and taking the gold/silver ratio down with it. This is usually a good indication of a gold/silver bull market – if this is the start of a sustained reversal.
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