global perspectives

Will US employment hold its ground?

Will US employment hold its ground?
Philipp Burckhardt, CFA - Fixed Income Strategist and Portfolio Manager

Philipp Burckhardt, CFA

Fixed Income Strategist and Portfolio Manager
Florian Ielpo - Head of Macro, Multi Asset

Florian Ielpo

Head of Macro, Multi Asset

In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we observe that the Federal Reserve’s aim to raise unemployment in its fight against inflation is starting to pay off, but will the central bank also be able to contain the upcoming recession?  

  

Need to know

  • The US job market remains solid but is now decelerating from its highs
  • Such a decline in the job market is the aim of the Fed in its fight against inflation, yet macro-observers should worry about this declining dynamic
  • While the consensus scenario is that any rise in unemployment will remain contained, poor job market conditions remain a risk and are poorly priced at present

 

Last man standing

The last man standing for US growth is employment. US growth is starting to show signs of slowing down, from the US housing market to consumer confidence and investment. The final barricade preventing all macro-observers from officially calling a recession in the US is employment. The most recent employment report favoured market bulls. The US economy is continuing to create jobs, and there seems to be no ‘but’ from the job report to jobless claims, so it remains hard to find a solid trace of poor conditions in the US job market, which is probably going to keep the Federal Reserve (Fed) unnerved for some time.

The truth is that two data points cannot determine a macro scenario and the direction of macro data matters just as much as their level. In terms of direction, we have started to see a downtrend in US employment. As 2023 begins, the key question is likely to be whether job deceleration will be the final sign we need to call a recession in 2023. It is a risk to the consensus at least and worthy of investigation.

 

Not saving private employment

Since the moment the Fed turned its ship away from dovishness to embrace the theory of demand-driven, persistent inflation, its eyes have been on the job market. The well-known Phillips curve relationship paves the way for central bank policy to shape the future of inflation: in order to see a decline in inflation, a higher level of unemployment is needed. By increasing rates through jumbo-sized hikes, the Fed has the explicit intent to create unemployment in order to bring inflation down. The mechanics is simply to push real yields higher by hiking rates and implementing quantitative tightening.

Higher real rates mean many things: they slow the housing market, create negative wealth effects and lead to a decline in private investment as credit becomes scarce and costly. A symptom of this taking affect is a deterioration in the job market; but as this is the ultimate consequence of all monetary policy channels, it usually happens last. The National Bureau of Economic Research’s (NBER) definition of a recession, and dating it, depicts rising unemployment as a necessary condition.

 Figure 1 measures economic activity versus the job market situation, with red dots highlighting the months the NBER has labelled recessionary. Its message is clear: job market deterioration is already happening in the US. ‘Deterioration’ does not mean ‘bad’, and this chart shows that we are clearly not yet in the worst situation. Deterioration means that the direction of the employment market is changing from positive to negative, probably as a consequence of Fed policy. This is step one for lowering inflation and sows the seed for step 2: a bad job market situation. Are we there yet?

 

Figure 1: Economic activity vs. employment in the US (red dots indicative of recession)

Multi-Asset-simply-put-Economy-employment-01.svg

Source: LOIM, Bloomberg.

 

The Fed’s angelic scenario

To answer that question, we need to understand what the consensus is – both for markets and for the Fed. The striking thing here is that market participants and the Fed agree on the same scenario, which can be broken down into two different elements:

  • Inflation should come back to a level close to central banks’ respective targets by the end of 2023, be it in the US or the Eurozone
  • Central banks will be able to deliver a soft landing, with negative growth not exceeding -1%

Lower inflation and constraining a recession: the best of both worlds. It took some time for the Fed and the European Central Bank (ECB) to convince investors of that scenario and the more credit we give to it, the likelier it is to happen – the famous self-fulfilling prophecy. Figure 2 illustrates the Fed’s scenario: unemployment should rise next year, without breaching the non-accelerating inflation rate of unemployment (NAIRU) level – the very definition of a soft landing.

Without dismissing that scenario as a base case, we have also added a model of the job market which has a one-month lead over the unemployment rate. This signal is already rising faster than both the market and Fed consensus, but we acknowledge that a decisive turning point cannot yet be confirmed. Our US growth nowcaster, shown below, depicts a similar conclusion: the real deterioration is probably happening quicker than expected. This point is essential as the recent rally feeds from this angelic consensus: should inflation be higher and / or growth be lower than expected then risk-on markets will likely see another round of volatility.

 

Figure 2. Recent evolution of the US unemployment rate in excess of NAIRU

Multi-Asset-simply-put-US-unemployment-01.svg
Source: LOIM, Bloomberg.

 

  Simply put, the US job market has already started to decelerate, but markets expect this to be cushioned. An accelerating trend would indicate that the market’s scenario is wrong and signals a call for prudence.  

 



Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. 

Our nowcasting indicators currently point to:

  • Our worldwide growth nowcaster is continuing to decline, and this is more pronounced in the US 
  • The inflation nowcaster is negative for China and the US. It remains positive in the Eurozone and the recent decline in European inflation data mainly reflects the evolution energy prices
  • Central banks’ hawkish stance should remain. However, over past weeks our monetary policy indicator has started to decline in the US and more recently in the Eurozone. This is in line with Fed chairman Powell’s speech at the end of November 

 

World growth nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Growth nowcaster-5Dec-01.svg

 

World inflation nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-05Dec-01.svg

 

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Monetary Policy nowcaster-5Dec-01.svg

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

important information.

For professional investor use only.
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name. This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Any benchmarks/indices cited herein are provided for information purposes only. No benchmark/index is directly comparable to the investment objectives, strategy or universe of a fund. The performance of a benchmark shall not be indicative of past or future performance of any fund. It should not be assumed that the relevant fund will invest in any specific securities that comprise any index, nor should it be understood to mean that there is a correlation between such fund’s returns and any index returns.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term “United States Person” shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorized and regulated by the FCA.
©2022 Lombard Odier IM. All rights reserved.