{"id":1455946,"date":"2024-02-07T17:50:00","date_gmt":"2024-02-07T22:50:00","guid":{"rendered":"https:\/\/bugaluu.com\/news\/?p=1455946"},"modified":"2024-02-07T17:50:00","modified_gmt":"2024-02-07T22:50:00","slug":"how-has-the-us-economy-remained-so-resilient-in-the-face-of-much-higher-rates-here-is-the-answer","status":"publish","type":"post","link":"https:\/\/bugaluu.com\/news\/how-has-the-us-economy-remained-so-resilient-in-the-face-of-much-higher-rates-here-is-the-answer\/1455946\/","title":{"rendered":"How Has The US Economy Remained So Resilient In The Face Of Much Higher Rates? Here Is The Answer"},"content":{"rendered":"

How Has The US Economy Remained So Resilient In The Face Of Much Higher Rates? Here Is The Answer<\/span><\/p>\n

\n

By Dhaval Joshi of BCA Research<\/em><\/p>\n

Summary:<\/strong><\/h2>\n

The markets have been celebrating the killing of inflation without the killing of the economy, but they have popped the champagne corks prematurely.<\/em><\/p>\n

Disinflation to date has been benign because it has come almost entirely from improving supply.<\/em><\/p>\n

But the supply-side tailwind has exhausted, so the last mile of the journey to<\/em><\/p>\n

2 percent inflation will be the hardest.<\/em><\/p>\n

Our bullish structural stance on bonds is intact given Powell\u2019s commitment that \u201cwe\u2019re not declaring victory at all at this point, we think we have a ways to go.\u201d<\/em><\/p>\n

But tactically the bond rally went too far too fast, warranting a neutral stance.<\/em><\/p>\n

If bonds consolidate, stocks are likely to consolidate too, also warranting a tactically neutral stance.<\/em><\/p>\n

<\/a><\/p>\n

The markets, and the Wall Street commentariat, have been popping the champagne corks. They have been celebrating the killing of inflation without the killing of the economy. Yet this celebration is premature, at least in the US and the UK.<\/p>\n

Through a simple sequence of charts, I will demonstrate that though the journey back to a sustained 2 percent inflation is possible without killing the US economy, it is not yet mission accomplished. The hardest part will be the last mile. I will then make a brief comparison with the UK and Germany.<\/p>\n

Markets Have Popped The Champagne Corks Prematurely<\/strong><\/h2>\n

The first chart in the sequence shows that to return US inflation to a sustained 2 percent, wage inflation must return to 3 percent \u2013 which is still way below the current 4.2 percent<\/strong>, as measured by the latest US employment cost index (ECI).<\/p>\n

<\/a><\/p>\n

Admittedly, over a shorter 6 months and 3 months, wage inflation is running at 3.9 percent and 3.5 percent respectively. But Jay Powell rightly counters that, given shorter-period inflation\u2019s volatility and reliance on error-prone seasonal adjustments, \u201cwe need some confirmation that inflation is, in fact, coming down sustainably\u2026\u201d Which is why \u201c12 months is our target.\u201d<\/p>\n

Another argument I hear is that the 1 percent gap between wage inflation and price inflation can be higher than its pre-pandemic average if productivity growth has gapped higher. But Powell correctly counters that this would be a dangerous presumption. Productivity growth will likely \u201cshake out to back where we were (pre-pandemic).\u201d Assuming this is true in other advanced economies, wage inflation must settle at 3 percent in those economies too.<\/p>\n

This brings us to the stunning second chart. For the past decade, the near-perfect driver of US wage inflation is simply the number of job vacancies.<\/strong><\/p>\n

<\/a><\/p>\n

The stunning simplicity of this chart makes perfect sense. By definition, a surplus of job vacancies reflects an excess demand for workers versus their supply, while wage inflation reflect the marginal price of workers. So, when the demand for workers far exceeded their supply, wage inflation surged<\/strong>. Then as the labour market rebalanced, wage inflation eased.<\/p>\n

The important takeaway from this stunning chart is that vacancies need to come down further to achieve a sustainable 3 percent wage inflation and 2 percent price inflation. As Powell puts it, \u201calthough the jobs-to-worker gap has narrowed, labour demand still exceeds the supply of available workers.\u201d<\/p>\n

The Recovery In Labour Supply Caused The Benign Disinflation\u2026<\/strong><\/h2>\n

The third chart gets to the crux of our analysis. The imbalance in the US jobs market and its subsequent rebalancing \u2013 causing the surge in wage inflation and then a benign disinflation \u2013 has been almost entirely about labor supply<\/em>.<\/strong><\/p>\n

<\/a><\/p>\n

We know this because, in 2021, when the economy reopened, the surge in the number of job vacancies precisely equalled the shortfall in the labour force that came from the collapsed participation rate. Likewise, the subsequent decline in vacancies through 2022-2023 has numerically tracked the declining shortfall in the labour force that came from a recovering participation rate.<\/strong><\/p>\n

As Powell puts it:<\/p>\n

\u201cWe lost several million workers at the beginning of the pandemic from people dropping out of the labour force. And then when the economy reopened in 2021, you had a severe labour shortage and it was everywhere. But then, labour force participation came back strongly in 2023, and so did immigration<\/strong>. And those two (supply-side) forces have considerably lowered the temperature in the labour market.<\/em><\/p>\n

\u2026But The Benign Disinflation Has Run Its Course<\/strong><\/h2>\n

The fourth chart reveals the story\u2019s denouement. The benign supply-side force \u2013 and the associated \u2018immaculate disinflation\u2019 \u2013 has run its course. The participation rate of prime aged (25-54) workers is now above the pre-pandemic level and topping out<\/strong>. Meanwhile, the participation rate of older aged (55+) workers remains stuck well below its pre-pandemic level reflecting the cohort of older workers who have permanently left the labour force. Meaning that the total participation rate is levelling out, below the pre-pandemic level.<\/strong><\/p>\n

<\/a><\/p>\n

All of this also solves a puzzle that has been perplexing many economists. How has the US economy remained so resilient in the face of much higher interest rates?<\/strong><\/p>\n

The fifth chart provides the answer. Fuelled by the strong rebound in participation through 2022-23, the labor force grew at a heady 2 percent clip.<\/p>\n

<\/a><\/p>\n

If we add in the unprecedented surge in illegal migrant workers who have crossed the Southwestern border, the true rate is likely closer to a blockbuster 3 percent.<\/strong><\/p>\n

<\/a><\/p>\n

Simply put, if the number of workers is growing at 3 percent, it is impossible for the economy not<\/em> to show resilient growth! Even in the face of higher interest rates. To repeat though, this powerful supply-side tailwind is exhausted.<\/strong><\/p>\n

If the last mile of labour market rebalancing cannot come from a benign increase in participation, then there are three possibilities: It must come from a further increase in immigration \u2013 legal or illegal \u2013 which is political dynamite. Or, it must come from a malign decrease in labour demand, meaning a downturn, which is also political dynamite. <\/strong>The third possibility is, as Powell says, \u201cthat inflation would stabilise at a level meaningfully above 2 percent.\u201d <\/strong>This would be politically easiest, but risk destroying the credibility of the central bank.<\/strong><\/p>\n

Turning briefly to Europe, the evolution in UK wage inflation is also largely the result of the post-pandemic imbalance between labour demand and the supply of workers, and its subsequent rebalancing.<\/p>\n

<\/a><\/p>\n

However, as I explained last week in BCA Research – The UK And Japan Are At Wage Inflation Extremes. Why?<\/a> the additional shocks of Brexit and the Russia\/Ukraine war mean that UK wage inflation, at 6-plus percent, is still far above the 3 percent where it must settle.<\/p>\n

As for Germany and the euro area, there has been no significant post-pandemic imbalance between labour demand and the supply of workers. Leaving the ECB with the luxury to cut interest rates before the Fed, and well before the BoE.<\/p>\n

<\/a><\/p>\n

Some Investment Conclusions<\/strong><\/h2>\n

Structurally, a bullish stance to bonds hinges on central banks not letting inflation stabilise at a level meaningfully above 2 percent and slip-sliding into an era of inflation akin to the 1970s. So far, this bullish structural stance is intact given Powell\u2019s commitment that \u201cwe\u2019re not declaring victory at all at this point, we think we have a ways to go.\u201d But any reneging on this commitment would require a rethink.<\/p>\n

Tactically, our recommendation to buy bonds (TLT) on October 12 and take profits at an 8.5 percent gain proved to be shrewd. The sharpness of the bond rally, premised on the premature popping of champagne corks, went too far too fast \u2013 based on its collapsing short-term complexity. This implies a near-term consolidation, warranting a tactically neutral stance to bonds.<\/p>\n

<\/a><\/p>\n

Meanwhile, while the S&P500 has grabbed the headlines for reaching an all-time high, the post-October rally is mostly on the coat-tails of the bond rally. So, if bonds consolidate, stocks are likely to consolidate too, also warranting a tactically neutral stance.<\/p>\n

Lastly, USD\/EUR has upside \u2013 because the Fed\u2019s rate cuts will be pushed out further than the ECB\u2019s and\/or because any consolidation or sell-off in stocks will favour the haven greenback.<\/p>\n<\/div>\n

Tyler Durden<\/a><\/span>
\nWed, 02\/07\/2024 – 12:50<\/span><\/p>\n

\u200bRead More<\/a>\u00a0<\/p>\n

\u00a0<\/p>\n","protected":false},"excerpt":{"rendered":"

How Has The US Economy Remained So Resilient In The Face Of Much Higher Rates? Here Is The Answer By Dhaval Joshi of BCA Research…<\/p>\n","protected":false},"author":0,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[1],"tags":[],"class_list":["post-1455946","post","type-post","status-publish","format-standard","hentry","category-news","wpcat-1-id"],"jetpack_sharing_enabled":true,"jetpack_shortlink":"https:\/\/wp.me\/pbimBl-66L0","jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts\/1455946","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/types\/post"}],"replies":[{"embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/comments?post=1455946"}],"version-history":[{"count":0,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/posts\/1455946\/revisions"}],"wp:attachment":[{"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/media?parent=1455946"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/categories?post=1455946"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/bugaluu.com\/news\/wp-json\/wp\/v2\/tags?post=1455946"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}