Just when we thought things were settling down, there was a series of surprises. First was the news of the Omicron Covid variant, which sent the markets into a (small) tailspin. Then US Federal Reserve Chair Jerome Powell acknowledged that ‘transitory’ was perhaps no longer an appropriate term to characterise inflation. And finally, the latest US non-farm payrolls numbers disappointed.
Given all these ‘upsets’, it is surprising how little has changed in the markets. Worries about Omicron sent the US S&P 500 equity index down by nearly 4% at one point, but it has since recouped its losses on initial signs that the variant is more infectious, but less dangerous. Like Delta, it is expected the latest wave will delay —but not derail — the reopening trade (see Exhibit 1).
European equities initially fell by more than US equities on the Omicron news as investors anticipated the greater inclination of governments in Europe to re-impose restrictions than is likely in the US. Indeed, while some European governments are moving towards vaccine mandates, similar proposals by the Biden administration have so far been delayed by the courts.
Inflation – A clarification
US investors then had to process Chair Powell’s comments that the Fed would drop the term ‘transitory’ to describe inflation. This was not so much an admission that the view was mistaken, but rather than it had not been understood in the way the Fed had meant.
Many investors read ‘transitory’ to mean that high inflation would last for only a limited period, whereas the central banker’s concept was that near-term inflationary pressures would not translate into a sustained higher rate of inflation in the future.
In fact, the Fed’s understanding corresponds with the view one saw in markets and surveys prior to Powell’s latest comments – a view that persists.
While near-term inflation expectations remain high (and certainly higher than the Fed had expected), market expectations for the level of inflation five to 10 years in the future are either still below pre-global financial crisis levels or no higher (see Exhibit 2).
One might have thought Powell’s more hawkish tone on inflation would have translated into market expectations of yet more policy tightening by the Fed.
Initially, estimates of the level of the fed funds rate in one year’s time (based on overnight indexed swaps) fell. This was likely due to market expectations of slower economic growth and a more cautious Fed in the face of the Omicron variant. However, even as Omicron worries fade (for now), expectations for the fed funds rate are hardly higher than they were before Powell’s comments (see Exhibit 1).
US labour market – Stronger than it may appear
The Fed has made it clear that it is not only inflation that will drive its decision on when and by how much to raise interest rates, but also its assessment of the labour market.
Disappointing non-farm payroll figures (just 210 000 jobs were created in November versus market expectations of 550 000) could been taken by the Fed as a sign that the tapering of its asset purchases in the lead up to a rate rise should be delayed, or at least not accelerated. Instead, markets now expect tapering to happen more quickly than the Fed had initially suggested.
There are several reasons why the Fed was not dissuaded by the release. It was just one month of poor data after several months of more encouraging job creation figures. The shortfall was primarily in restaurants and bars; in most other industries, job growth was still good.
Moreover, civilian employment is continuing to rise rapidly, and actually accelerated sharply in November (see Exhibit 3).
Much has been made of the historically high proportion of workers quitting their job, although one should recall that it is still low in absolute terms, at just 2.8% of the workforce in November.
The comparatively high level, however, is arguably a sign of the US labour market’s strength, not its weakness. Workers who quit their jobs are not choosing not to work; more often, they are simply taking another, likely better paying, job. Given the tight US labour market, it should not be surprising that many workers are looking for better opportunities.
Moreover, the post-pandemic economy will likely be different in many significant ways. This reshuffling of the US labour market is simply the process of reallocating labour to the more productive or higher growth activities of the future.