Friday, February 2, 2018

US Wage Inflation Spooking Markets?

Matt Belvedere of CNBC reports, Fed's Kashkari: Wage growth is good for workers, but maybe not so much for stock investors:
Minneapolis Federal Reserve President Neel Kashkari, who voted against all three interest rate hikes last year due to low inflation concerns, told CNBC on Friday the January employment report is "one of the first signs" of wage growth.

"That's good for the public as a whole. I think it's good for the economy overall. But I do think if wage growth continues that could have an effect on the path of interest rates," he said on "Squawk Box" from Minneapolis. Higher rates tend to put pressure on the stock market because bond yields start to look more attractive.

The Fed is expected to hike rates three times in 2018. On Wednesday, Fed officials held rates steady after their two-day January meeting, the last one for Janet Yellen as Fed chair.

"The most important thing that I saw in a quick review of the jobs data is wage growth," Kashkari said. "We've been waiting for wage growth. Everyone's been declaring we're at maximum employment. More Americans have been coming in, which is a really good thing. But there hasn't been much wage growth. This is one of the first signs that we're seeing wage growth finally starting to pick up."

The Bureau of Labor Statistics reported earlier Friday that average hourly earnings gained 0.3 percent for the month, reflecting an annualized rise of 2.9 percent. Meanwhile, the economy added a greater-than-expected 200,000 nonfarm jobs last month. The unemployment rate was 4.1 percent.

Kashkari, who became Minneapolis Fed president in 2016, is not a voting member this year on the central bank's policymaking panel, the Federal Open Market Committee. But he was an FOMC voter last year, casting the lone dissent on rate increases in March and June. Chicago Fed President Charles Evans joined Kashkari in voting against the December rate hike.

"We've been undershooting our inflation target for basically 10 years. And there's been very muted wage growth," Kashkari told CNBC as a reason for his objections. "There [also] might be some slack still in the labor market."

Kashkari came to the Fed with experience in government and on Wall Street. He was the administrator of the Treasury Department's Troubled Asset Relief Program during the 2008 financial crisis. After leaving Washington, he joined bond giant Pimco as a managing director and head of global equities. He also unsuccessfully ran as a Republican for governor of California in 2014. Before his time at Treasury, Kashkari was a vice president at Goldman Sachs.

Kashkari also reacted to the new Republican tax law. "I've been surprised about how much optimism has come from the tax cut. And the tax cut, think of it as short-term stimulus. Can it boost GDP this year? Yes. It is going to lead to a long-term shift in GDP growth? It's too soon to tell."

As for all the companies who have offered onetime bonuses due to the tax changes, he said, "I think a little bit they are playing to the political moment; we're going to do out part and we're going give one-time bonuses. More compelling to me is the wage increases themselves." citing some companies that raised their minimum wages.
As I explained last Friday in my comment on the danger of irrational complacency, Trump's tax cuts won't offset the impending slowdown.

US nonfarm payrolls rose by 200,000 in January, beating analyst estimates, while the unemployment rate held at 4.1 percent. More importantly, average hourly earnings increased 2.9 percent on an annualized basis, the best gain since the early days of the recovery in 2009.

Much attention has been given to the increase in average hourly earnings as proof that wage increases are taking hold.

But as Zero Hedge rightly points out, there's more to the wage growth story than the headline figure suggests (click on images to enlarge):
With attention firmly fixated on today's wage print earnings, economists - not to mention the Trump administration - were delighted to see a 2.9% spike in average hourly earnings, the biggest jump since June 2009, suggesting inflation is about to make a roaring comeback, and prompted the likes of Bill Gross to predict that the 10Y would hit 3.0% in the very near future.


Well, not so fast, because as a closer look at the data reveals, the only reason why average hourly earnings rose, is because the total weekly hours worked posted a relatively steep decline, dropping from 34.5 in December to 34.3 in January, a 2.9% drop from the 34.4 last January.


Meanwhile, average weekly earnings actually declined from December, dropping from $919.43 to $917.18 from December to January...


... which in turn meant no breakout in the average weekly earnings, which rose a far more modest 2.6%, and in fact declined from recent prints above 3.0%.


Finally, looking at the broadest segment of the labor force, the production and non-supervisory workers, average hourly earnings rose only 2.4%, indicating that the bulk of wage gains once again accrued to managers and supervisors.


So before dumping that 10Y or buying the dollar on the surge in "hourly" wages, maybe a question worth asking first is why did the average workweek decline by 2.9%, because if it had kept constantly, average hourly earnings would have barely increased, and the market's reaction would be vastly different.
Indeed, the 10-year Treasury yield jumped to a four-year high of 2.85% after a better-than-expected jobs report reflected rising wages. The yield also got a boost from stronger-than-expected consumer confidence numbers (click on image):


Still, in his analysis, Krishen Rangasamy, senior economist at the National Bank of Canada, notes the following:
The U.S. employment reports for January were mixed, with a generally good establishment survey (a consensus-topping 200K increase for non-farm payrolls) but a less impressive household survey (just a 91K increase for employment after removing the effect of updated population estimates). The reported increase in non-farm payrolls was not broad-based according to the slumping private sector diffusion index, while hours worked fell at the fastest pace in four years. But the FOMC, which wants to continue normalizing monetary policy, will focus on the positives including further jobs gains in cyclical sectors such as manufacturing and construction, and the acceleration of average hourly earnings in the private sector to 2.9% on a year-on-year basis, the highest since 2009. As today’s Hot Charts show, the uptick in wage growth is largely due to services-producing industries which, with current technology, are less easy to automate than say goods-producing industries (click on image).
So there seems to be a tale of two economies, higher wages in professional services but languishing wages in manufacturing and construction.

Count me as part of the skeptics who do not see sustainable wage gains going forward. Bond bears will jump all over this data as convincing evidence that wage gains are taking hold and inflation will continue rising but with new minimum wage increases kicking in in January across some states and weather-related factors, it's hard drawing any conclusions from one month's data.

More worrisome, with credit card debt at a record high and personal savings as a share of disposable income falling rapidly, the US economy is already flashing a warning signal, one that tells you inflation expectations will remain muted over the next year.

But thus far, the bond market is buying the inflation scare and the rise in long bond yields this week is making everyone nervous. At this writing on Friday afternoon, the Dow is down over 600 points and it's been a rough week:



Add to this that earlier this week, Renaissance Technologies, the world’s most profitable hedge fund, said there’s a “significant" risk of a correction in prices and is preparing for possible market turbulence, and everyone is very nervous about markets.

But I'm not interested in what RenTech is stating publicly, show me their book and only then can I tell you whether they're positioned defensively or not.

Also, go back to read my comment from earlier this week on why you should ignore scary bond market stories. I updated that post to include a comment from Cam Hui of Pennock Idea Hub, The Pain Trade Signals From the Bond Market, where he explains why they feel the bond market is poised for a rally.

I particularly like the two charts below from Cam's comment (click on images):



And when I look at the weekly decline in US long bond prices (TLT), I'm inclined to believe we're close to a bottom in prices, a top in yields here (click on image):


Even if US long bond yields continue to rise next week (long bond prices continue to fall), I see this as a big buying opportunity in US Treasuries. And if long bond yields reverse course, it will help ease the pressure off stocks, so don't get too flustered just yet despite the weekly selloff in equities (click on image):


Notice even after a rocky week with some big declines, the S&P 500 (SPY) remains above its 10-week moving average, so it's not the time to panic just yet.

It is time, however, to start thinking of your overall portfolio risk and shifting to a more defensive stance. I have gone over my thoughts on sectors you need to be looking at in my Outlook 2018: Return to Stability.

Take the time to reread this comment very carefully and pay particular attention to sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecom (VOX).

Interestingly, the back-up in long bond yields has created better buying opportunities for some of these interest rate sensitive sectors, so focus your attention there.

Is there a big crash coming in the bond and stock market? I don't think so and I'm not worried. The S&P was up 6% in January, an unbelievably great start to the year, so it's only normal that we're seeing a pullback. By Valentine's Day or even sooner, I'm sure we'll see more love for stocks coming through.

But others are more worried. Below, Miller Tabak's Matt Maley sees high yield's lack of participation in the rally as a warning signal. "It is a yellow flag," Maley told CNBC's "Trading Nation." "The high-yield market was dead flat, the HYG was dead flat in January and yet the stock market had a really good gain."

I've discussed the canary in the coal mine but when I look at high yield bonds (HYG), I don't see any reason to panic yet (click on image):


So try to relax this weekend and don't get too caught up with articles on wage inflation and how rising bond yields will kill the stock market. As far as I can see, this is just another normal pullback.

Also, take the time to listen to Danielle DiMartino Booth of Money Strong discuss the latest US jobs reports on Boom Bust. Danielle offers great insights on why wage gains are unlikely to persist and why the Fed needs to pay attention to the nuances in the jobs report.

Hope you enjoyed this and other comments and remind all of you who value these insights to kindly donate or subscribe on the right-hand side under my picture. I thank people who take the time to contribute, it's greatly appreciated.


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