One of the least pleasant economic environments for investors is that of “stagflation”.
Growth remains weak, so it’s hard for companies to earn money. But inflationary pressures stay high, so margins are squeezed and monetary policy stays tight.
The latest US jobs data has some commentators already reaching for the “s” word.
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Are they right to be worried?
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The US jobs data springs a nasty surprise
The latest jobs data in the US showed its economy added 235,000 jobs in August.
That was a big disappointment. In normal times, that’d be a huge number, but we’re not in normal times. We’re meant to be recovering from a big economic shutdown and we’re hearing about labour shortages across the board. So markets had expected the figure to come in at more like 730,000.
Needless to say, that’s a big miss.
We shouldn’t necessarily jump to conclusions. There are lots of reasons why this might have happened.
Most obviously, the last 18 months have been really weird. You can’t expect statistical series – even long-running ones – to be as reliable as usual at times like these. This data is full of estimates, guesstimates and assumptions.
Even at the best of times, the non-farm payrolls data is very prone to revision. I’ve commented here before on how ridiculous it is that the market takes it so seriously. A big miss or a big gain can drive big swings in the market – and then a month later, the figure can be revised to show the exact opposite.
Indeed, the gains for July were revised up to 1.05 million from an already very strong number.
However, if the data is relatively accurate, then what does it suggest? Most analysts reckon that the big issue is the Delta variant of the coronavirus.
As Paul Ashworth of Capital Economics points out, Delta may not just be scaring off customers, it may be putting people off returning to the labour force as well. “Close to three million [potential workers] are still missing compared with the pre-pandemic level.”
Yet at the same time, wage inflation remained strong. Despite the weak reading for actual job numbers, wages rose more strongly than expected, up by 0.6% month-on-month, and 4.3% year-on-year (accelerating from 4.1% previously).
As Ashworth adds, this puts the Federal Reserve – the US central bank – “in an uncomfortable position – with the slump in the real economy and employment growth accompanied by signs of ever more upward pressure on wages and prices.”
From an investor’s point of view, there are two things that matter here. One is that every weak piece of data gives the Federal Reserve another excuse to delay normalising monetary policy. At the Jackson Hole conference the other week, Fed chairman Jerome Powell stuck with the story that the US central bank will start to “taper” by the end of this year, perhaps announcing it as soon as this month.
However he also emphasised the importance of the Fed’s employment target. So if the data implies that we’re further away from “full employment”, then the Fed is not going to be keen to rock the boat by being overly aggressive on tightening. I suspect that the wage data won’t matter as much to Powell and colleagues as overall employment levels.
You can see this thinking in the initial reaction to the weak data. The US dollar was a little weaker, gold was a bit stronger, and stocks ambled about a bit before deciding they weren’t too bothered.
Are we heading for stagflation again?
The second thing to keep an eye on is what this says about the economic recovery. We’re already starting to see “stagflation” headlines cropping up all over the place. This disappointing jobs report has only added to that concern.
Stagflation is a toxic mix of weak growth and high inflation – similar to what we saw in the 1970s. That’s not a decade that any investor particularly wants to repeat.
It’s understandable why this is a concern. The “misery index” – which just involves adding the unemployment rate to the inflation rate – is extremely high relative to recent decades, what with unemployment remaining above pre-pandemic levels and inflation picking up sharply.
In my view, it’s probably a little early to worry about stagflation. I am quite sure that inflation is going to become a longer-term issue and won’t be “transitory”. What I’m less concerned about right now is growth.
Delta has knocked back progress on lots of fronts, and supply chains are a particular issue right now. But there’s still a lot of demand out there (otherwise wages wouldn’t be going up). And you would hope that, as a result, unemployment will fall – there’s certainly plenty of demand for labour out there.
So I wouldn’t be worrying about stagflation quite yet. But it’s certainly worth keeping an open mind.
We’ll be discussing the topic in more detail in a forthcoming issue of MoneyWeek magazine. Get your first six issues free here if you haven’t already subscribed.
Until tomorrow,
John Stepek
Executive editor, MoneyWeek
