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Written by: Tim Pierotti
Over the weekend, Renaissance Macro’s outstanding market economist Neil Dutta made a compelling argument that there is mounting evidence that a potential inflection in unemployment may be upon us. The US Economy’s 7-Deadly Sins Neil has been among the most outspoken dovish economists in recent months even saying that if the Fed doesn’t cut in December, it would be a “borderline scandal”. Just to be clear, Neil is not someone who always sees the sky falling. He is someone who remained quite constructive on the economy throughout 2023 when so many others were bearish. His track record is so good because he tends to be the guy who says, relax, the economy is fine. I don’t disagree with much of what he wrote about regarding the risk of a weaker job market, but I would note that he doesn’t discuss the fact that the Fed has a dual mandate and it is on the inflation side where they have abjectly failed. That is the crux of the problem the Fed faces. Both sides of the dual-mandate are going in the wrong direction and they have to make a decision that will worsen their position. The only question is to what degree. Simplify’s Michael Green recently referred to the Fed as being in “Zugzwang”, a situation where any move, in any direction, begets more unfavorable options.
Mr. Dutta’s case for the Fed getting more aggressive is that the slow gradual rise in unemployment to levels that remain tight by historical standards risks becoming ‘nonlinear”. In other words, history tells us clearly that what looks like gradual jobs weakness at first can rapidly become a deluge of layoffs. He looks at the housing market and makes the intuitive observation that you can’t have housing permits rolling over with new inventory making new highs and yet construction jobs at highs. Other sectors like restaurants, state and local governments, freight and transportation are all sectors that he sees as likely to be shedding jobs at an increasing rate over the near-term. Lastly, Mr. Dutta points to the NY Fed’s consumer survey which tells us that people feel less confident that they could find a job were they to be let go than at any point in the last ten years.
While I agree with these observations broadly. One issue I do have with the bearish labor view is that we are in an unprecedented time in terms of the scarcity of labor. Economists now put the amount of new jobs needed to keep the unemployment rate flat at somewhere between 0 and 50,000, as opposed to the long-held belief that we needed to create roughly 150,000 jobs every month. The labor market simply isn’t growing. More people my age (over fifty) are leaving the job market and not enough young people, with skills, are looking to replace them. Obviously, immigration at roughly zero is also contributing to the labor scarcity issue. According to the National Federation of Independent Businesses (NFIB), the biggest concern business leaders say they have every month is the ability to fill open roles with qualified people. So, hiring may be weak, but that may in part be driven by a scarcity of qualified candidates. The second area where I may be more sanguine than Mr. Dutta on the labor market is that corporate profits aren’t exactly rolling over. Profit growth has been accelerating lately according to small businesses as well as in larger public companies. It is hard to see an inflection in layoffs at a time where overall profit growth is going in the right direction.
But even if we accept the arguments of the bearish labor market observers, is it fair to say that therefore the Fed should absolutely be cutting? I don’t think it is. We are soon to be entering the fifth year of Fed running above or well above the Fed’s 2% target. While risk assets love a Fed that allows the economy to run hot and is ready to cut at the earliest signs of market weakness, the average American suffers amid high inflation. High long-run inflation means a higher cost of living for those who don’t have the buffer of assets and savings that also inflate.
My guess is the economic data between now and the December meeting will look soft enough the Fed will again cut rates. They will say that they have confidence that inflation will fall to their target in the year after next, just like they said last year. They will say that tariff driven inflation is inherently transitory and should be ignored despite the fact that we remain in the early days of higher cost of goods impacting consumer prices. My guess is that until there is real pressure on the long-end of the yield curve, until the fabled “bond-vigilantes” appear, the Fed will continue to be responsive to financial markets and one side of their mandate while ignoring a cost-of-living crisis for working Americans.
Related: Why Americans Don’t Believe the White House on Inflation