“Indicators of longer-term inflation expectations appear broadly consistent with our longer-run inflation goal of 2%. If we saw signs that the path of inflation or longer-term inflation expectations were moving materially and persistently beyond levels consistent with our goal, we’d be prepared to adjust the stance of policy.”
– Chairman Jerome Powell recent comment reported in Barron’s
We have long held the view that a recession isn’t necessarily one of the worst economic conditions, but the environment of persistently rising costs combined with weakening growth may be worse than an outright contraction. An economic recession is a time when growth turns negative, as national output contracts. Unemployment rises, profits fall and the stock market, in an anticipatory fashion, tends to enter a bear phase.
However, for investors that period tends to bring forward declining interest rates and, with it, increasing bond prices. For balanced investors, while they may be dealing with lower stock prices, that decline is at least partially offset by rising bond prices. Not so with a period of stagflation, which is a period of declining economic growth rates (note, I didn’t say negative growth rates) and higher inflationary pressure. When both conditions are met at the same time, stock prices tend to struggle and bond prices tend to retreat as interest rates rise.
A question many need to ask isn’t how rapidly the economy will grow, or how high sustained inflation pressure may prove, but rather, will both negative events occur at the same time? The Federal Reserve has made it clear that, of their two congressionally-driven mandates (full employment and stable price environment), their policy currently favors the full employment side. See Chairman Powell’s recent comments mentioned above where he continues to discount the sustainability of the recent upward push in inflationary pressures. I hope he is correct; that the increased inflationary rates are transitory in nature and not systemic. It appears to me that the pressures may indeed be more systemic than Chairman Powell would currently prefer to consider.
We’ve been suggesting that the probability of stagflation is real. We stand by that view. While a period of sustained stagflation isn’t our core case outlook (we think inflation will cool to the mid-2% range next year, and economic growth likewise will cool to a real 2.5% rate), the risk of stagflation occurring appears to be rising. A significant driver of a stagflationary environment is the jobs market. Not only the availability of jobs, but wage growth rates tend to add sustainability, or the lack thereof, to rising inflationary pressure. We are seeing continued signs that wage growth rates, which have accelerated, may be real, and may be sustainable. If so, the Fed may need to shift gears and relaunch their inflation-fighting tools. If this proves correct, the longer the Fed waits to act against rising sustainable inflationary pressure, the worse the problem may become.
To state the obvious, employment matters. Rising wage growth rates, unaccompanied by a sustained increase in worker productivity growth tend to lead to an upward push in sustainable inflationary pressure.
The unemployment rate troughed in early 2020 at 3.5%, prior to the onset of the COVID pandemic. It peaked at 14.8% in April 2020, and has since fallen to 5.9% in June.1 There were 9.2 million available, unfilled jobs at the end of May and 9.5 million unemployed members of the workforce. 2 Nonfarm payrolls have risen by 15.6 million since the low reached in April 2020, they are still 6.8 million less than was the case at the peak in February 2020.3
So, employers are wanting people to come back to work. In many cases, workers are unwilling to do so. Consider the following reasons why the unemployment rate seems to have stalled: Is the problem wages? Perhaps; however, the employment-cost index has risen at its fastest pace in 15 years, according to the Bureau of Labor Statistics, wages are rising. Workers are demanding higher wages to return to work.
Other explanations as to why some people are unwilling to return to work include:
- Concerns of rising COVID risks: With the building of the Delta variant, some are deciding the health risks to be too uncertain to venture back to the workforce.
- Lack of affordable childcare: Even if they are school aged, many may not be physically returning to school due to mitigation efforts against COVID.
- The extra $300 in federal monthly unemployment benefits: Some in Washington say this benefit, which expires in September nationally if it isn’t renewed, isn’t the reason folks are staying at home. Data suggests this assessment isn’t accurate. A recent report from Jefferies says continuing unemployment claims fell by 24% since mid-May in the states that have already cut the extra $300 per-month payment compared to a 0.7% increase in claims in states that have maintained the extra benefit. My conclusion: Money matters.
- As the baby-boom generation has matured, many who turned 65 delayed retiring, that is until the pandemic hit: The Pew Research Center said that in July 2019 (prior to the pandemic), the majority of workers born between 1946 and 1964 (baby boomers) were still working, with the oldest among them staying in the labor force at the highest annual rate for people their age in more than half a century. That trend has changed. A report authored by Professor Geoffrey Sanzenbacher of Boston College shows that 15% of people over age 62 were retired a year after the COVID virus took hold, as compared to 10% a year following the recession of 2007-2009. In other words, the rate of retirement has accelerated compared to historical trends.
- A change in how people think of their work/life balance: According to Barron’s, a record number of new businesses launched during the pandemic as workers decided to take advantage of the lock-in and changed economic environment. Additionally, the rash of “day-traders” that has occurred is keeping some away from the labor market.
So, what can employers do? The question is what will bring the remaining 6.8 million unemployed who had jobs prior to the COVID onset back to the jobs market? They can raise wages, which has been happening. But perhaps not rapidly enough.
According to data from the New York Fed, which attempts to gauge people’s willingness to work, the factor is called the “Reservation Wage,” and is the minimum paycheck that someone would accept for a new job. The inputs for this number are from the Survey of Consumer Expectations and is broken down by demographic groups. The latest survey was from March.
Among its findings and changes from the previous year:
- The mean annual reservation wage was $71,400, a 15.7% increase.
- For workers under age 45, the increase was 17.3%, and for those over age 45, the increase was 14.1%.
- For workers without a college degree, the increase was 26.1%, compared to 6% for those with a degree.
- Women’s responses showed a mean increase of 18.4% against an increase of 11.1% for men.
- For those who were making less than $60,000 per year, the increase was 16.4% compared to an increase of 2.9% for those making more than $60,000.
This all brings a few questions to mind. First, which types of businesses may need to increase wages rather aggressively to bring their full workforce back? Think young, less-educated women. Think service companies, which tend to be very labor intensive and tend to pay lower-than-average wages. Food service and hotels come to mind. Secondly, and perhaps more importantly, what does this mean to the macro economic environment? If we see anything like a 16% broad-based wage increase (the mean increase in the reservation wage), then the impact on inflation may indeed be not just noticeable, but undeniably significant, or business profit margins would be impacted in a big way.
It is too early to say that a significant upward push in wages is needed to bring folks back to work. But the seeds have been planted, and worker expectation of higher wages may indeed be in the cards.
As a sidebar item, with the intensification of the Delta variant, the extension of federal unemployment benefits of $300 per month may occur. If this happens, several of the reasons behind people not coming back to work, and the reservation wage rising even further may be in store.
By the time this report is made public, we will have seen the July employment report from the Bureau of Labor Statistics. Expectations are calling for around 800,000 new jobs for the month; a very strong report. We can hope this will be the case. We will stay in touch regarding this important trend.
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