A New Paradigm
It’s been an eventful stretch of late for both markets and the economy. Last Friday we had a seemingly blowout May nonfarm payrolls report. This week was dominated by soft CPI and PPI price data along with the Federal Reserve FOMC meeting and the Powell presser on Wednesday. Let’s get to it.
Last Friday, May nonfarm payrolls came in at 272,000, crushing consensus expectations to the upside by nearly 100,000. The immediate market reaction was trepidation that with the labor market apparently booming, market participants might not get the year-end rate cuts they crave. On the strong headline release, the market hawkishly repriced late-year Fed rate cut expectations down to one lonely cut from two previously and a far cry from the nearly seven cuts priced in at the start of the year.
Headlines, however, can often be misleading. Digging into the report, the portrait painted was totally contradictory and, in some cases, downright ugly. The BLS payrolls report contains two surveys. The household survey and the establishment non-farm payroll survey. The two surveys usually sing the same tune, but these are unusual times. Friday’s report revealed a staggering divergence. While the Establishment survey surged by 272,000 payrolls, the Household survey tumbled with a loss of 408,000 jobs.
In late 2021, on a six-month annualized basis, both surveys were in lockstep, recording a similarly strong growth rate. While the Establishment survey boasted payroll growth of 5.8%, the Household survey (from which the unemployment rate is calculated) was growing at a stout 5.9% rate. As of last Friday, however, on a six-month annualized basis, the Establishment non-farm survey was growing at 2% while the Household survey had slipped into a -1% contraction.
Data for the two series dates back to 1948. While there have been discrepancies between the series historically, the current disparity is totally unprecedented. Household job growth has never been as negative as it is today, while Establishment payroll growth has remained as strong as it appears today. In fact, the gap that’s opened up since the divergence began between these two surveys is now a stunning nine million, and is the biggest on record.
What’s worse, job quality is also suffering. On net, we are losing full-time jobs and replacing them with part-time jobs. Part-time jobs have grown by 1,511,000 over the last year, and have outpaced full-time job growth of negative 1,163,000 over the last year for the sixth consecutive month.
The observation of a lack of clarity out of the BLS on the U.S. employment picture isn’t unique to HAI. Following the payroll release, Bloomberg’s chief economist Anna Wong commented:
“May’s jobs report presented contradictory views of the labor market, as we expected. The establishment survey shows robust gains in nonfarm payrolls—yet the unemployment rate rose to 4.0%. We believe the latter currently offers a closer approximation of reality than payrolls, as BLS’ model for estimating business births and deaths—which added 231,000 jobs to the nonfarm-payrolls print in May—is lagging the reality of surging establishment closures and falling business formation. We think the underlying pace of current job gains is likely less than 100,000 per month.”
Interestingly, in addition to HAI and Anna Wong, color Jay Powell a sceptic of the BLS payroll numbers. On Wednesday, the Fed Chair himself said “There’s an argument that they [non-farm payrolls] may be a bit overstated…”
Additionally, Wong has previously noted that initial jobless claims, which have remained historically low, have also been structurally understating the actual number of layoffs. This week, for the first time in over a year, initial claims popped significantly and were well above expectations. US Initial Jobless Claims came in at 242,000 vs. a consensus estimate of 225,000 and well above the previous 229,000 reported. It’s just one week of initial claims data, and California’s new minimum wage law might have skewed the results, but this series will have to be watched very closely going forward.
As for data on inflationary price pressures this week, all price survey data reported downside misses across the board. The Consumer Price Index (CPI), the producer price index (PPI), and US Import Prices all came in soft and surprised to the downside.
Headline CPI was 0.0% M/M vs. an expected 0.1% and down from 0.3% previously. On a year-over-year (Y/Y) basis headline CPI came in at 3.3%, down from 3.4% previously. Core CPI (ex-food and energy) also improved with a 0.2% M/M read vs. 0.3% expected and 0.3% prior. Y/Y core CPI was 3.4% vs. 3.6% prior.
Headline US PPI was actually negative in May. M/M headline PPI was -0.2% vs. a 0.1% estimate, and down hard from 0.5% previously. Core PPI was 0.0% in May vs. a 0.3% estimate, and also down significantly from 0.5% prior. Adding to the theme of cooler prices in May, the US Import Price Index (M/M) was down -0.4% vs. an estimated -0.1%, and down dramatically from 0.9% previously.
With the smoothed six-month annualized growth rate at 3.2% for headline CPI and core CPI at 3.5%, May was a good month, but there has still been no overall progress since the end of last year for Y/Y core CPI and for headline CPI. There’s still been no progress since July of 2023 on the Y/Y reading. Energy prices were the biggest contributor to lower headline prices, and as energy price volatility continues, we can expect broad price gauges to remain volatile. That said, with “overstated” job numbers, a significant pop in initial unemployment claims data, an unemployment rate that has trended up materially from a cycle low of 3.4% to 4% now, and a sudden cooling of May inflation data, attention will now turn toward whether we are beginning to see a more pronounced slowdown in economic activity.
Goldman Sachs has already turned cautious on the consumer. In a note to clients this week, the bank warned of “signs of weakening consumer sentiment towards the lower-end [the recent drop in consumer confidence], rising credit card delinquencies, depleting savings, cautious management commentary, and HundredX analysis suggesting intentions for curtailed purchases, and increased value-seeking behavior going forward.”
Goldman’s consumer caution was backed-up by Friday’s UMich consumer sentiment survey dropping to a fresh seven-month low. The surveys of consumers report showed that preliminary June sentiment was down 5.1%, while current economic conditions tumbled 10.2% on “rising concerns over high prices as well as weakening incomes.”
The consumer, however, might already be one step ahead of Goldman. CPI Prices in the nondiscretionary (needs) category continue to run hot from a historical perspective, while that of discretionary (wants) has cooled significantly. When breaking down CPI according to these categories, May’s nondiscretionary inflation came in at a robust 4.7% Y/Y vs. discretionary inflation at a tepid 0.1% Y/Y increase. If the inflation in prices of the things people need is high while the prices of things people want ease, consumer stress along with a resulting behavioral shift is already implied in that data.
This is as good a time as ever to remind the reader of the two-sided risk to this economy. For over a year, we have been waiting for signs and confirmation as to whether this economic cycle would terminate in inflationary fire or recessionary ice. With inflation rebounding at the start of the year while the Fed continued guiding towards inflationary rate cuts anyway, the odds shifted towards an inflationary outlook. But with recent weaker data and a Fed that, at this week’s FOMC, sounded marginally more hawkish despite a cooling of inflation in May, it’s good to remember the wisdom of HAI favorite economist Dr. Lacy Hunt. In Dr. Hunt’s most recent letter to clients, he cautioned that, “The consensus forecast believes the economy is buoyant, supported by robust labor markets and a resilient consumer…[but] the contractionary effects of monetary policy and the de facto negative NNS [Net National Savings] policy stance of fiscal policy will serve to place increasing downward pressure on inflation and growth.“
If Dr. Hunt is right, and we continue to see downward pressure on inflation and growth while the Fed—for now—remains higher for longer, it’s “be careful what you wish for.” A hard landing is by no means priced into this stock market. If Dr. Hunt is right, the market may be seriously underestimating the amount of emergency rate cuts coming, possibly sooner than anyone thinks.
In the event of either inflationary fire or an icy recessionary hard landing, HAI likes the risk/reward profile in gold far more than the very at risk and severely bloated valuations of the S&P 500.
Two weeks ago, HAI chronicled a very important Bloomberg interview with former Global Head of Commodities Research at Goldman Sachs, Jeff Currie. In the interview, Currie observed that many major nations were no longer automatically recycling their dollar-denominated commodity and oil revenues back into US Treasurys as a reserve asset.
To refresh, Currie said, “For the first time ever, that dollar recycling is not occurring. And what is replacing it? I like to call it gold recycling [and] It explains a lot, why gold prices are as strong as they are… They’re going to trade with one another using local currencies. And then, whatever it nets out in settling, they would settle in gold… You’re unlikely to see that dollar recycling playing out probably ever again.“
In HAI‘s view, that “dollar recycling” Currie is referring to was a key mechanism creating a 40-year-bull-market-turned-bubble in US Treasurys. Similarly, the new “gold recycling” is also likely to be extremely bullish for the gold price. This week, Currie hit the interview circuit again on MacroVoices and expanded upon his discussion of gold.
“Central banks are not recycling dollars at the same rate they were before, but instead buying physical assets, and bartering with other commodities. It shows that this is a new paradigm. You know, as someone jokingly said to me the other day, it’s like the emerging markets are trying to force us back onto the gold standard.” Currie continued, “these forces, they’re not going to change, they’re not going away, they’re probably going to get more embedded as we go forward… They’re likely to grow stronger, and gold is going to be a central part of this.“
That’s exactly right. While some market commentators have belittled talk of any threat to the US dollar from expectations of a coming BRICs currency, they miss the fact staring them right in the face: the “new” default BRICs currency is actually rather old. It’s gold. Accordingly, the outlook for the gold price is much higher.
Weekly performance: The S&P 500 was up 1.58%. Gold was up 1.04%, silver was nearly flat, up 0.11%. Platinum was down 1.29%, and palladium was down 2.72%. The HUI gold miners index was off 0.41%. The IFRA iShares US Infrastructure ETF was down 0.82%. Energy commodities were volatile and mixed on the week. WTI crude oil was up 3.34%, while natural gas was off 1.27%. The CRB Commodity Index was up 1.52%. Copper was up 0.26%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 1.29%. The Vanguard Utilities ETF was nearly flat, off 0.09%. The dollar index was up 0.30% to close the week at 105.17. The yield on the 10-yr U.S. Treasury was off 21 bps to close at 4.23%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
