Despite hawks flying everywhere, the crowd sees nothing but doves.
With pivot mania reaching new heights on Jan. 6, the bulls have convinced themselves that a pre-pandemic monetary policy environment is on the horizon. But, we’ve warned for many months that the outlook is highly bullish for the U.S. federal funds rate (FFR), and the fundamentals continue to unfold as expected.
For example, the crowd was screaming recession in the summer of 2022, and those fears were amplified in October. However, we rebutted that demand was resilient, and the U.S. labor market remained on solid footing. To that point, with U.S. nonfarm payrolls outperforming the consensus estimate on Jan. 6, it was another data point that aligned with our expectations.
Please see below:
Source: Investing.com
In contrast, with average hourly earnings coming in at 4.6% year-over-year (YoY) versus 5% expected, the crowd once again decided that the inflation fight was over. Conversely, with the metric only decelerating by ~20 basis points YoY versus November, the excitement contrasts the fundamental realities.
Please see below:
As evidence, while the crowd cherry-picks data that supports their narrative, we prefer to use multiple sources; and with other measures showing robust wage inflation, the crowd is uninformed about the inflationary backdrop.
For example, while the Atlanta Fed should update its Wage Growth Tracker at the end of next week, the metric was north of 6% in November.
Please see below:
Second, ADP’s private payrolls report (released on Jan. 5) showed even higher wage inflation. We wrote on Jan. 6:
Source: ADP
To explain, the report showed that job-stayers and job-switchers recorded 7.3% and 15.2% increases in their median annual pay. For context, the latter pertains to Americans that leave their jobs for other opportunities.
Likewise, the industry breakdown highlights how all areas of the U.S. economy experienced wage growth of more than 6%, and the figures do not support the Fed normalizing output inflation to 2% anytime soon.
Third, Indeed’s Wage Tracker shows that salary inflation is still running at 6.5%.
Please see below:
The Dec. 8 report stated:
“Posted wage growth may return to its pre-pandemic pace late next year. Overall wage growth tends to trail gains for new hires. That means overall wage growth may not get back to pre-pandemic levels until well into 2024. We are still in the early innings of this wage slowdown.”
Moreover, while the crowd follows the narrative instead of the data, the reality is that objective measures of wage inflation are 6%+. As a result, investors are in la-la land if they think the economic backdrop supports a dovish pivot.
Now, it’s one thing for the fundamentals to unfold as expected. It’s another for the price action to follow suit; and with the PMs outperforming in recent weeks, not only has the consensus ignored the ramifications of a higher FFR, but they expect the exact opposite. To explain, we wrote on Jan. 6:
The lack of demand destruction in the U.S. labor market highlights why the FFR should have plenty of room to run. Furthermore, while Fed officials continuously issue hawkish warnings, their plethora of post-GFC pivots have the crowd viewing them as ‘The Boy Who Cried Wolf.’ But, this is not 2018 or 2020, and more QE can’t solve this fundamental predicament. So, when reality returns, the PMs should undergo substantial re-pricings.
Thus, the PMs’ recent strength comes down to investors not buying what the FOMC is selling. In their minds, the Fed will pivot in 2023, and the pre-pandemic paradise of low inflation, low interest rates and perpetual QE is on the horizon.
Conversely, we warned repeatedly that dovish pivots alongside high inflation occur when the economic outlook is dire. In addition, recession fears outweigh rate-cut optimism and liquidations are already underway.
Yet, the current economic backdrop is far from dire, and we have consistently remarked that investors’ recession fears are overdone. As such, the fundamental outlooks remain bullish for the FFR, real yields, and the USD Index, and the crowd underestimates the medium-term ramifications.
Please see below:
To explain, U.S. third-quarter real GDP growth was revised upward twice, and the Atlanta Fed’s projection for Q4 (the green line above) stands at 3.8% as of Jan. 5. Consequently, the crowd’s pivot optimism contrasts economic reality.
To that point, with the official data released on Jan. 26, the shorter the time until the print increases the validity of the Atlanta Fed’s projection.
Please see below:
To explain, the blue line above tracks the root mean square error (RMSE) of the Atlanta Fed’s real GDP projection, depending on the days until the official data is released. For context, it measures the average difference between the predicted and realized value, and is used to determine how well a model predicts a target value.
If you analyze the right side of the chart, you can see that the RMSE declines as we move closer to the official GDP print, and even a realized error of ~1% still puts Q4 GDP growth above its pre-pandemic trend of ~2%. As a result, the narrative and the data continue to diverge, and the uninformed pivot optimism rivals the PMs’ other bear market rallies in 2022.
Continuing the theme, the U.S. unemployment rate declined to a ~50-year low on Jan. 6, which highlights how the FFR has not risen enough to materially slow the U.S. labor market.
Please see below:
Source: Investing.com
Likewise, the strength has the unemployment rate outperforming the median estimates from the FOMC’s Summary of Economic Projections (SEP).
Please see below:
To explain, the red line above tracks the FOMC’s median SEP estimates for 2022 and beyond, while the blue line above tracks the monthly unemployment rate. If you analyze the performance of the latter, you can see that its December decline pushed it further from the FOMC’s desired trajectory. As such, the results are hawkish, not dovish, as demand for labor still outweighs supply.
Overall, the narrative has shifted from an imminent recession to a soft landing that returns the U.S. economy to its pre-pandemic state. With employment still hot and the U.S. Bureau of Labor Statistics’ (BLS) measure of wage inflation cooling, the crowd viewed the results as the perfect combination for resilient growth and 2023 rate cuts.
Conversely, those developments are mutually exclusive, and resilient economic data should keep inflation uplifted and spur more rate hikes, not less. Therefore, while the gold price has benefited from the false narrative, a profound reversal should occur over the medium term.
As always, we encourage your input. Do you think wage growth could slow dramatically in the months ahead? And if so, why? How would the Fed respond? And why should we expect low interest rates and QE to resume sooner rather than later?
Alex Demolitor
Precious Metals Strategist