By Michael Every at Rabobank
Payrolls, inflation, missiles - and the missing link
Friday’s payrolls were not quite what many in the market had wanted to see. Yes, they are backwards looking; are distorted by the infamous births-deaths model that has even less idea what to be doing right now than it usually does; and the broadest measures of unemployment like U-5 and U-6 are drifting upwards again. However, the headline number that most people think really matters was 390K vs. 318K expected and average hourly earnings were in line at 5.2% y-o-y. In short, there was nothing there to force the Fed to back off of what are now very public plans to hike 50bps in June, and July, and September, and then take it from there. (And perhaps have to take it even higher, with some talk of 3.5% as a terminal rate.)
So, higher rates look locked in. The problem is, so do higher energy prices.
Brent was at $121.36 in Asian trading this morning, and over the weekend the Saudis raised their selling prices for both Asia and Western Europe, while keeping it unchanged for the US. The White House will take that small win but is running through a playbook of (bad) ideas as to what to do next: kiss up to Venezuela, whose own oil industry is in ruins; to Iran, despite the rapidly-crumbling nuclear deal; or to the “pariah” Saudis, who keep underlining there is not a lot more they can do, especially regarding refining capacity, which would take 3-5 years to bring online if the US started today, which it’s not close to. It’s of course out of the question to kiss up to Russia.
How about China then? Even as the US continues to focus its national security energies on Beijing, President Biden is apparently considering lowering some tariffs on Chinese imports such as “household goods and bicycles”. Talk about “On your bike!” Such a move would have a maximal impact on perceptions of US geopolitical weakness given China, like Russia, is aware it controls supply chains; it would have an impact on Congressional races in the November midterms (negatively for Democrats, regardless of how much Wall Street would love it); and it would have a minimal impact on inflation.
Yet CPI remains the key economic focus this week for both the White House (“How do we get inflation down without reversing our actions that helped to push it higher?”) and markets (“How do we get inflation down without reversing our actions that helped to push stocks higher?” US CPI is out on Friday and is seen up another 0.7% m-o-m, so 8.4% annualised, and 8.3% y-o-y, even if the core measure is expected to edge down to 5.9% y-o-y from 6.2%.
Putin apparently remains fully convinced the West cannot deal with the suffering he is helping to cause, and its elites will crack under his foot-on-the-hose commodity pressure. Is he wrong? We already see tensions between France/Germany and Ukraine/the east of the EU. Some openly wonder how long the US will remain committed when there is a long road ahead.
Friday marked 100 days of the Ukraine war: the current trend suggests it will prove no more important a number than 10 did. Russia will keep going to achieve its geostrategic goals; Ukraine will fight to the bitter end; and the best Western observers underline even a pause would only end up with Russia coming back for more, involving more countries. Indeed, following new missile attacks on Kyiv aimed at newly-arrived military aid from the West, Russia’s Medvedev has warned if Western artillery are used against Russian territory then its armed forces “will have no other choice but to strike decision-making centres. It needs to be understood that the decision-making centres in this case are not located on the territory of Kyiv.”
Does he mean Warsaw, Prague, or Bratislava? Vilnius, Tallin, or Riga? Berlin, London, or Paris? Or even Washington, DC? If you want a further symbol of where Europe sits, pro-Russian Serbia is not about to receive the invited Russian Foreign Minister Lavrov, because none of its immediate neighbous would provide overflight rights for his plane. Meanwhile, neighbouring Croatia is close to joining the Euro, and some fear Bosnia may be pulled apart entirely.
So, we have payrolls; we have inflation; and we have missiles. The missing link for markets is how these actually join up, as opposed to ‘here is headline A’; ‘here is headline B and C’, etc.
If the West is going to win this geoeconomic struggle, it will have to involve supply chains: they must move nearer. Indeed, as the appropriately-titled SupplyChainBrain blog notes in an op-ed, “Over the next 12-18 months, companies will be witnessing an avalanche in slow motion. Even as the pressure of cargo and vessel backflow begins to ease, there’s no turning it around. And, as it runs its course, it will continue to alter the geopolitical and market landscape in ways both predictable and unknown.… companies that lack the insight and agility to avoid the worst of it are those most likely to be buried.” That might be surprisingly good for payrolls going forwards.
If the West is going to win this geoeconomic struggle, it will have to involve rates: they must move higher. They *cannot* be used as tool to stimulate aggregate demand when aggregate supply is deliberately choked off by geopolitical rivals, as we are accustomed to in more normal times. They *cannot* be used to push up asset prices to compensate for a lack of pay for most workers, as we pretend we are not doing in new normal times. The Fed *cannot* pretend it is in control of shadow banking and Eurodollar markets that are funding commodity-price speculation, as it does all the time. That all won’t be good for payrolls going forwards.
Markets still don’t seem to really grasp this. Some participants see the recent shift back towards ‘fiscal and monetary policy’ just drives up inflation if the supply is not there. Well done. Some also see there is a geopolitical clash underway (far, far away, and ‘hopefully over soon’). A prize to them too. However, they both refuse to join the dots that the West cannot enjoy its flimsy festering fat fiat fiesta forever.
This does not mean a commodity-backed global alternative to the dollar is around the corner: far from it. Yet if a stronger, more integrated Western geoeconomic response to its multiple challenges is not, then much worse global chaos might well be. For example, oil is at $121 and rising, and China is not up and running yet. (As the Caixin services PMI at just 41.4 vs 46 consensus shows, albeit up from 36.2.)
Yet most in markets are wondering when it will be time to buy X or Y again. The underlying view is still that the below is where we ultimately end up, if not now, then soon, despite meaning sustained inflation and the erosion of Western hegemony:
Knowing something about both inflation and the erosion of hegemony, today sees the UK drag itself back from four days of sunshine, Platinum Jubilee Bank Holiday, lemon curd cheesecake trifle, and marmalade sandwiches… straight into a political crisis, as PM BYO may face a leadership challenge. If one does not arise this week, it seems certain to later in the month after the government is crushed in two different kinds of byelection. Don’t expect that backdrop to be kind to GBP, which is looking as leggy as both the PM and the pantheon of very elderly stars wheeled out for the recent concert outside Buckingham Palace.