It seems safe to say that 2022 is shaping up very differently from the experience of investors in 2021.
US equity volatility hit its highest level since March 2020. The S&P 500 index has already eclipsed last year’s biggest drop with its seventh worst January since 1950 – narrowly avoiding entering territory correction (-10%) while the Nasdaq approached a bear market (-20%).
With inflation high and US economic growth slowing from above-average levels, the prospect of tighter monetary policy is attracting investors’ attention. At the January Federal Open Market Committee meeting, US Federal Reserve (Fed) Chairman Jay Powell made it clear that rate hikes should begin in March.
Stock market volatility historically peaks around Fed fundraising. The silver lining is that these sell-offs generally present buying opportunities for long-term investors: positive returns on average over the six, 12 and 18 months have followed the start of the last four rate hike cycles.
Futures markets are forecasting increases of 1.2 at the March Fed meeting and 4.9 overall by the end of the year. As of mid-September, fed funds futures were not pricing in even a single full rate hike for all of 2022. Pricing for four rate hikes in the past four months is a significant move on a brief period.
Half of the Fed’s dual mandate is nearly satisfied as the jobless rate fell below the Fed’s estimate of long-term unemployment, boosted by consecutive months of strong job gains. This means that it can be more aggressive in managing inflation.
While wage growth, a component of headline inflation, is high, labor market data remains skewed due to the COVID-19 pandemic. The US Bureau of Labor Statistics (BLS) continues to stress that data collection remains a challenge, especially when measuring hourly workers. They may not appear on company payrolls if they are sick at home, although salaried workers do. This can skew jobs and wage figures during a spike in cases as workers are required to stay home and self-quarantine.
The difference between the number of sick workers and the typical amount for the same month in the decade before the pandemic, called “excess sick workers”, can be useful in analyzing the impact of the pandemic on the labor market.
Surplus sick workers have dwindled and sunk during the pandemic, increasing during the Omicron and Delta waves and decreasing in the spring and early summer of 2021 when case numbers plummeted.
The number of excess sick workers had a strong relationship with payroll gains. This confirms the idea that measurement problems related to the pandemic continue to have an impact on the establishment survey, and therefore on the number of non-agricultural employees and the resulting wage gains.
If hourly workers – usually less well paid – are even slightly undervalued, this has a disproportionate impact on hours worked in relation to wages paid and mechanically pushes average hourly wages upwards. This dynamic was evident in the April 2020 jobs report, when 20.5 million jobs disappeared, coupled with a surprising +4.6% month-over-month wage increase due the much larger share of lower paid jobs lost.
This helps explain why the Fed tries to focus on other wage measures, such as the Employment Cost Index and the Atlanta Fed’s Wage Growth Tracker. Their methodologies are less sensitive to these issues although they also show high wage pressure, although less than the broader surveys.
All of this influences perceptions of the health of the labor market and the Fed’s decisions on rate hikes. If jobs are undervalued and wages overvalued, the Fed may have less incentive to hike as aggressively (relative to market expectations). This dynamic will likely only become clear as the United States and the world enter the endemic phase of the virus, hopefully in the next few quarters.
The impact of these distortions may be smaller than we think, or even non-existent – simply an oddity in the data emerging from a small sample during a noisy period. Yet there are several good reasons why the health of the labor market may be more robust than commonly believed.
If so, the Fed’s surprise in this “transition year” could turn out to be a more dovish than hawkish second half.
Jeffrey Schulze, CFA, is a director and investment strategist at ClearBridge Investments, a subsidiary of Franklin Templeton. Its predictions are not intended to be considered predictions of actual future events or performance or investment advice.
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