On the One Hand…
On the Other Hand

The Bank of England raised interest rates for the second consecutive time. This was widely expected and brings the base rate up from 0.25% to 0.50%. Four of the nine members voted in favor of a 50 basis point rate hike, suggesting at least some desire from members to tighten even faster. Like the Federal Reserve, the Monetary Policy Committee apparently felt the need to act swiftly to cool inflationary pressures with consumer prices forecast to hit 7.25% in April 2022. On the flip side, the European Central Bank (ECB) decided to hold rates unchanged and did not change its guidance. ECB President Christine Lagarde said that it is very unlikely that the ECB will raise rates before the end of 2022, but financial markets are pricing in 40 basis points of rate hikes by December.

The Institute for Supply Management’s manufacturing and services indices remained elevated and suggest that the U.S. economy continued to expand in January. Although the ISM manufacturing index fell from 58.8 in December to 57.6 in January, that level is consistent with a U.S. economy that growing at a modest pace. The downside of the report is that the prices paid component rose yet again…rising from 68.2 in December to 76.1. While input costs are rising at a slower rate, they continue to climb and suggest that peak inflation may still be a ways off.

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U.S. President Harry Truman famously asked to be sent a one-armed economist because he was tired of economists saying, “On the one hand, this” and “On the other hand, that.” Presumably, the President was looking for a definitive answer rather than a wide range of outcomes. We suspect that President Truman probably would not have liked the January employment report because on the one hand…it was well above expectations…but on the other hand…it supports the Federal Reserve’s view that the economy is strong enough to warrant tighter monetary policy. With monetary policy uncertainty elevated, we think that incoming economic data will likely be viewed in the context of what it means for monetary policy until the Fed provides needed policy clarity. The employment report is a prime example.

The White House warned investors that the January employment report could be ugly with the spike in Omicron cases in January likely to have a pronounced effect of the January jobs report. Instead, the January employment report showed the economy adding 467,000 jobs – well above the highest forecast of 250,000 jobs. Another surprising element was that the leisure and hospitality sector showed little impact from the surge in Omicron cases with the sector adding 151,000 jobs in the month – close to the pace the sector maintained throughout the fourth quarter of 2021. The net revisions to the two prior months were also strong with an upward revision of 709,000 jobs. Though tempting to say that Omicron appeared to have no impact, underlying details did show that a record high 3.6 million people were unable to work due to illness (see figure 1). Just over 6.0 million people were not able to work because their employer was either closed or lost business because of the pandemic. Absent the Omicron surge, the report likely would have been even stronger.

This graph shows people who have a job, but are not at work due to illness.

Another interesting component of the report was the average hourly earnings print, which jumped from about 5.0% year-on-year in December to 5.7% year-on-year in January. While one could argue that the jump in wages means that inflation is becoming entrenched, we would caution against reading too much into one data print as it could have been distorted by Omicron if employers were forced to pay overtime to healthy workers who are covering for sick workers. That said, the largest wage gains year-on-year have been seen in sectors like leisure and hospitality (+13.0%), education and health services (+6.8%), and transportation and warehousing (+6.8%) which seems to suggest that employers in the most COVID-impacted sectors are facing stiff competition for workers (see figure 2).

This bar graph shows the Average Hourly earnings of all employees as a year-on-year percent change.

Why the Context Matters for Markets

Overall, great employment report, but the market reaction was mixed. That’s because good economic news can be bad news when viewed in the context of what it means for Federal Reserve monetary policy. The employment report supported the Fed’s recent hawkish pivot and, as a result, led to markets pricing in an even more aggressive Fed. Following the report, the odds of a 50 basis point rate hike jumped from about 20% to about 35% currently. The odds of more than five Fed rate hikes by year-end jumped to about a one-in-three chance. Until investors get more clarity on the path of monetary policy, incoming economic data may result in elevated volatility as investors consider a wide range of outcomes from the Fed’s imminent tightening cycle. As an economist might put it, “On one hand…on the other hand.”

The upcoming January release of the consumer price index (CPI) is likely to be yet another example of a data print viewed solely for its impact on monetary policy expectations. Interestingly, not even one of the economists surveyed by Bloomberg News is predicting inflation to decline with the consensus expecting inflation to rise from 7.0% in December to 7.3% in January. We will be watching the NFIB’s small business optimism survey, which is released a day prior, for clues to January’s inflation print with the percentage of small businesses planning to raise prices often tracking inflation quite well (see figure 3). Given the policy backdrop, investors may be hoping that the uniform call for higher inflation serves as contrarian indicator.

This line graph shows the Percentage of Small Businesses Planning to Raise Price vs. U.S. Inflation

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