On Friday, we got the latest news on the state of the US jobs market.
It was, to use the technical term, a "blowout" report. For those of us still fighting a vain rearguard action against the Americanisation of the language, that means it was very good indeed.
That's good news for the economy. But what does it mean for markets?
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Strong employment is good for the economy – but it might scare markets
On Friday, we learned that in July, US employers took on nearly one million people. In all, 943,000 jobs were added to payrolls. That was comfortably above the median economist estimate of around 870,000, and the largest gain since August last year.
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There were also upward revisions to the figures for both June and May, with a total of 119,000 more jobs added than previously estimated. (Note that this is a valuable reminder that this data is very prone to being revised, even though traders act as though it is gospel truth on the day of its release).
Meanwhile, the unemployment rate dropped to 5.4%. That's the lowest it's been during the pandemic period, and it was down from 5.9% in June.
On top of all that, hourly wages were up by 0.4% in July for the second month in a row. For context, that means wages are now rising at an annual rate of 4%. That's a big leap, and according to Andrew Hunter of Capital Economics, it means US wages are now rising at the fastest rate in 14 years, even if you adjust for Covid-related disruption.
In short, everything in this report points to an ongoing strong recovery with sustained inflationary pressure thrown in for good measure.
This is good news from an economic point of view. A strong recovery is what we need after the big shock of Covid, and from a longer-term perspective, the profit pendulum could do with swinging in labour's direction having spent a long time favouring capital.
But if you're an investor, there's a more immediate question. What does it mean for monetary policy?
The Federal Reserve has been at pains to emphasise that the signs of a strong economic recovery so far don't necessarily spell an imminent end to bond buying (the dreaded "taper"), let alone higher interest rates. The Fed has been keen to see "substantial" progress towards "full employment".
Some (including me) argue that this is also something of a fig leaf for the Fed to hide behind. Ultimately, the world's central banks wouldn't mind too much if inflation ran a bit "hot" for a prolonged period. That would help to deal with the massive debts that have been taken on to pay for all the measures that were designed to cushion the impact of Covid-19.
How does that work? Let's say the national debt is costing a government 2% a year. If GDP grows at 3% a year, it's easy to keep repaying the interest on that. But the beauty here is that it doesn't matter if it's "real" growth or just inflation - the debt gets repaid in "nominal" terms, not inflation-adjusted terms. So if inflation stays higher than interest rates, creditors get repaid in devalued dollars and the whole thing can be cleared much more easily.
That's financial repression at its finest.
However, a very strong jobs report like this makes it much harder for the Fed to justify sitting on its hands. It implies that loose monetary policy might get tighter more quickly than markets had hoped.
The market reaction tells us all we need to know
From that perspective, it was very clear from the market reaction just what investors fear this means for interest rates.
Gold dropped hard. The yellow metal had spent the last few weeks or more dithering around the $1,790 to $1,830 range. It plunged right through the bottom of that range towards the $1,765 mark. Gold doesn't like the prospect of higher interest rates (although if inflation rises more rapidly than rates do, gold will be just fine, which is why I'm still happy to hang onto it for now).
Meanwhile, longer-term US government bond yields headed higher, implying higher interest rate expectations. The US dollar rose too. (A country's currency becomes more appealing if rates look likely to rise due to a stronger economy).
So what's likely to happen? To be fair, the market has been expecting some sort of "tapering" announcement to happen in September's Fed meeting. The main change is that this now seems "very likely" rather than just "quite likely".
The next big event to watch is the annual central banker shindig at the US resort of Jackson Hole. That happens towards the end of this month between August 26th and 28th.
US Fed boss Jerome Powell will give us his view of things. In light of this report, I'd expect him to be keen to calm the market down and make sure it knows the Fed will be advancing slowly but surely.
I still expect the Fed to remain "behind the curve" - in other words, prone to letting inflation rise more rapidly than interest rates (or rate expectations). But we'll see what happens.
It's also worth remembering that if we're genuinely in boom conditions, it's hard to see that being bad for equities. At least in the short run - although there is a point at which inflation starts hurting equity returns and it's quite possible that we'll get there sooner than expected.
If you want to know more on that – and about how to prepare your portfolio for more inflationary days – I covered the topic in the current issue of MoneyWeek magazine, out now. You can get your first six issues free if you subscribe right now.
