US employment: more sludge

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Good morning. President Donald Trump has re-escalated his rhetoric against Iran, threatening to bomb its power plants and bridges if it doesn’t reopen the Strait of Hormuz, and using bad language to do so. As with most of Trump’s threats, it’s hard to say whether he will follow through. What is clear is that Iran knows control over the strait is powerful leverage. Send your predictions for how this plays out: [email protected] 

More of the same on jobs

A quick summary of the last 10 US employment reports: bad, good, quite bad, quite good, very bad, good, bad, very good, very bad, very good. There is a pattern there if you look at the reports sequentially. Looking at them as a whole, there really isn’t much going on. This newsletter has been guilty, on and off, of trying to see movement up or down, but really the labour market is just staggering sideways. In the chart below, jobs lost or created jump around in each month (light blue line) but the six-month moving average (dark blue line) is flat at zero. Or maybe there is a little upward progress? Get out your magnifying glass:

When a good month hits — as one did in March, with 178,000 jobs added — expectations for Federal Reserve rate cuts decline and the bond market shudders a little. But this month was just the flipside of the previous month. And even the one-month spurt in job creation is less striking when you look at the totality of the labour market data that came in last week: job openings remain soft, the hiring rate is weak, and wage growth slowed. The picture is still stable but utterly devoid of dynamism or, in a single word, sludgy. 

Looking at jobs outside of government, health and social care, to get a sense of the cyclical side of the economy, there is visible if slow improvement. But this is a case of “less bad” rather than “good” — and who knows how the rise in energy prices will affect the economic trend:

Where does that leave the Fed? Still stuck where it is. The unemployment rate is lowish and the participation rate is highish. Inflation was already about a percentage point above target before the war in Iran started, and the war will force the Fed to worry about high energy prices leaking into core inflation or into inflation expectations. Cuts don’t make sense, and neither do increases, unless inflation leakage starts.  

(Armstrong)

Are the late 2020s the new late 1960s?

The energy shock has many pundits and investors drawing parallels to the 1970s. But Richard Bernstein at Janus Henderson argues that a better comparison is the “guns and butter” era of the 1960s — when Lyndon Johnson’s “Great Society” fiscal spending splurge coincided with Vietnam war military spending. Bernstein explains: 

If the [One Big Beautiful Bill] is indeed as big as advertised, then history might eventually view the 2020s’ Guns & Butter as being based on a coupling of defense spending with sizeable tax cuts . . . It appears the new Guns & Butter fiscal policy could result in higher-than-expected inflation and budget deficits. Importantly, the significant fiscal stimulus of tax cuts and defense spending is arriving when the labour markets are already healthy. Jobless claims are showing strength resembling the readings during the 1960s Guns & Butter period.

Here’s a long-term chart of core inflation, with the guns and butter era highlighted, showing how inflation ignited:

Bernstein argues that with inflation primed to rise, shorter-duration investments such as small-cap stocks and even cash should outperform. Traditional fixed income and investment-grade corporate credit had negative absolute returns during the 1960s, essentially the opposite of the longer-duration investments growth stocks and long treasuries that dominate standard 60-40 portfolios today. Bernstein’s chart: 

Bernstein’s view has elements in common with that of economists like Adam Posen, who argue that tariffs, fiscal expansion, and dovish monetary policy will lead to higher inflation later this year (see here). The basic logic is compelling, but the analogy between the late sixties and today can only be pushed so far. The Vietnam war went on for years; whether the current war will last or lead to a lasting increase in the defence budget remains to be seen. And the growth impact from today’s “butter,” mostly tax cuts for corporations and well-to-do households, might be lower than the Great Society programmes of the 1960s. Right now, mild stagflation looks as likely as 60s-style strong growth and higher inflation.

And while Bernstein is right to point out the low level of unemployment claims then and now, the job market was clearly tighter then. The unemployment rate was at historic lows and falling, rather than rising as is the case today:

Another difference: both the market and the Fed are much more conscious of inflation risks today. The “guns and butter” thesis laid out above depends on inflation surprising investors and the Federal Reserve being too slow to act. Given recent experience, this seems unlikely.

(Kim)

One good read

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