Despite calls for a dovish pivot, the data does not support investors’ enthusiasm.
With gold, silver, mining stocks and the S&P 500 ending the Jan. 5 session in the red, a hawkish data deluge zapped some of the recent optimism. Moreover, while the crowd continues to follow the post-GFC playbook (wait for a dovish pivot), the post-pandemic imbalances are far from resolved, and the ramifications are far from priced in. To explain, we wrote on Dec. 27:
We've warned repeatedly that a major decline in U.S. GDP growth and the labor market are required for a dovish 180; and with economic output revised higher twice in Q3, and tracking north of 3% in Q4, the fundamental backdrop supports higher, not lower, interest rates.
Also, with resilient employment still far from the levels required to normalize wage inflation, continued hiring only strengthens the case for a higher FFR in 2023…. The Fed needs employment to contract to reduce wage inflation. In contrast, U.S. firms are still increasing their headcount, which intensifies the imbalance between labor demand and supply.
Consequently, it’s no wonder why the Atlanta Fed’s Wage Growth Tracker and the U.S. Bureau of Labor Statistics' (BLS) average hourly earnings metric both re-accelerated in November; and the longer this persists, the more it supports a higher peak FFR.
To that point, while the crowd has been flat-footed in its assessment of the economic backdrop, our fundamental thesis continues to unfold as expected.
Please see below:
Source: Bloomberg/ZeroHedge
To explain, the green line above tracks Bloomberg’s U.S. Labor Market Surprise Index, while the red line above tracks the inverted (down means up) Goldman Sachs Financial Conditions Index (FCI).
As it relates to the former, the green line rises when an economic data point outperforms economists’ consensus estimate; and with resilient employment prints hitting the wire in recent months, they continued to defy expectations.
As a result, while the U.S. federal funds rate’s (FFR) rapid rise helped propel the FCI higher (red line falling), the U.S. labor market remains resilient, and highlights why the FFR needs to rise even more to create the demand destruction necessary to reduce inflation.
Remember, JOLTS job openings outperformed expectations on Jan. 4, and there are nearly 4.5 million more job openings than unemployed Americans. Thus, the Fed needs to eliminate the excess to bring labor supply and demand back to its pre-pandemic equilibrium; and since we’re nowhere near that point, the prospect of a dovish pivot was, and still is, out of touch with economic reality.
As further evidence, ADP released its National Employment Report on Jan. 5; and with private payrolls coming in at 235,000 versus 150,000 expected, the hawkish implications are underestimated by market participants.
Please see below:
Source: Investing.com
Furthermore, while ADP's data does not correlate well with U.S. nonfarm payrolls in the short term, it's extremely useful in gauging the health of the U.S. labor market.
Please see below:
Source: ADP
To explain, the report stated that a “job resurgence was seen in the last two months of 2022,” and that “hiring was strong across small and medium establishments.” In addition, if you analyze the table above, you can see that the employment gains were broad-based, with the U.S. service sector experiencing increases across most industries.
Even more revealing, the wage inflation results highlight why the FFR should seek higher ground in 2023.
Please see below:
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.
So, while we warned throughout 2021 and 2022 that the crowd underestimated the resiliency of demand, the dynamic is still present in 2023. As such, the fundamental outlooks are bullish for the FCI, the FFR, real yields and the USD Index, and we expect all four to surpass their 2022 highs in 2023.
Continuing the theme, Challenger, Gray & Christmas Inc. released its job cuts report on Jan. 5. An excerpt read:
“U.S.-based employers announced 43,651 cuts in December, falling 43% from the 76,835 announced in November. It is up 129% from the 19,052 cuts announced in the same month in 2021.
“In 2022, employers announced plans to cut 363,824 jobs, up 13% from the 321,970 cuts announced in 2021. It is the second-lowest recorded total since Challenger began tracking monthly job cut announcements in 1993, with 2021 being the lowest.”
Please see below:
In addition, while consolidated job cuts rose by 13% year-over-year (YoY), the results were highly resilient for a few reasons.
- 2021 saw the lowest annual job cuts on record, which skews the 2022 YoY comparison to the upside.
- The Fed hiked interest rates 17 times in 2022 (25 basis point increments), and economic activity should slow when the FFR rises.
But third, the boom-and-bust environment spurred by unprecedented pandemic stimulus had an outsized effect on the technology sector; and with layoffs concentrated in this industry, the consolidated figures are better than they appear on the surface. The report added:
“The bulk of cuts remain in the Technology sector. In December, 16,193 cuts occurred at companies in this industry for a total of 97,171 for the year, the leading job-cutting industry in 2022. It is up 649% from the 12,975 that occurred in Technology in 2021.
“With the downturn in cryptocurrencies, Fintech firms announced 1,670% more cuts in 2022 than the prior year: 10,476 cuts in 2022 compared to 529 in 2021.”
Thus, the technology sector accounted for 37% of December’s job cuts, which highlights the strength present in other industries.
Please see below:
Overall, the fundamentals continue to align with our expectations: the economic backdrop supports a higher FFR, which makes the outlook bearish for risky assets like gold. Remember, when risk-free assets offer a return of 4.25%+, with the yield poised to rise with the FFR, it reduces the attractiveness of risky assets that can experience capital losses.
Consequently, while the dovish pivot crowd assumes that rate cuts will sink the FFR, lower the return of risk-free assets, and propel risk assets higher, their optimism should suffer a crisis of confidence in the months ahead.
Alex Demolitor
Precious Metals Strategist