Weekly Investment Update (08/05/2022)
- Labor market: Labor market remains hot, signaling the Fed has more to do in this tightening cycle.
- Economic surveys: ISM Survey data shows cooling manufacturing but strong services report; both surveys point to easing supply constraints and inflationary pressures.
- Bank of England: The Bank of England tightened monetary policy while also forecasting a recession.
Labor Market Remains Tight; Fed’s Job Not Yet Complete
The U.S. jobs report for July was much stronger than anticipated. The U.S. economy added 528K jobs in July, more than double the projected 250K and higher than the 398K jobs added in June. The unemployment rate fell to the February 2020 pre-pandemic low of 3.5%, the lowest level seen since 1969. The labor force participation rate ticked down by 0.01% to 62.1%, and wage growth ran ahead of expectations, rising 0.5% for the month. A falling unemployment rate and declining labor force participation suggest continued wage pressure.
The surprisingly strong jobs report may appear at odds with recent signs that initial jobless claims are creeping higher as well as job cut announcements. However, looking beneath the surface, one can see the forces at play in the economy through the discrepancies across sectors. For example, we have seen some job cut announcements in fast-growing industries like cryptocurrency that likely over-hired in the past few years while the jobs report shows strong demand for jobs in leisure and hospitality, sectors that drastically cut jobs during COVID and are now experiencing the effects of reopening and pent-up demand. While initial jobless claims have increased and stand at the highest level since the end of November 2021, they have not reached a level that would constitute concerns regarding job growth. The JOLTs data for June came in at 10.7 million job openings, down around 605K versus May, a larger decline than anticipated; however, there were still 1.8 job vacancies per unemployed job seeker.
Today’s jobs report signals to the Fed that the economy is operating at a very robust level and can likely endure tighter monetary policy, lowering the chances of a Fed pivot in the near term. The market is now pricing a greater likelihood of a 75bp hike versus a 50bp hike at the September meeting. Fed officials reiterated a moderately hawkish tone this week, stating the market may be getting ahead of itself in pricing in policy easing in 2023 as the Fed has not yet achieved its goal of combatting inflation. While Fed officials express confidence in achieving a soft landing, it is evident their job is not yet done.
ISM Surveys Diverge; However, Inflationary and Supply Constraints Ease
This week, the Institute for Supply Management (ISM) released survey data gauging manufacturing and service sector economic activity. Notably, the services data stood in contrast to the manufacturing data. The data showed that growth in the U.S. services sector unexpectedly strengthened to a three-month high in July on firmer business activity and orders, while the ISM manufacturing survey edged down. Manufacturing grew at the slowest pace in just over two years as more factories dialed back production in the face of shrinking orders and rising inventories as goods demand continues to fall given consumer shift to services spend after the economy reopened post-COVID.
Despite the divergence in the headline composite numbers, both surveys indicated easing supply constraints and inflationary pressures. Price components of both the manufacturing and service indicators fell, with the manufacturing price reading the lowest in two years and services price index decreasing for the third consecutive month in July. Given the latest readings, we look forward to next Wednesday’s CPI report to see whether the report corroborates these leading indicators.
Bank of England Delivers Rate Hike While Forecasting Recession
At its August meeting, the Bank of England delivered a 50bp rate hike and a quantitative tightening plan while also forecasting the economy will enter a recession starting next quarter, highlighting the perilous position in which the U.K. economy currently finds itself. The bank's projections show inflation peaking at 13.1% and still running at 9.5% in a year. While the main driver of high and prolonged inflation in the U.K. is the energy crisis exacerbated by the war in Ukraine, it is worth noting how long the bank believes it will take for inflation to ease from current high levels.
The bank reiterated monetary policy is not on a predetermined path and the bank remains ready to move forcefully should inflation prove even more persistent than expected. Given the size of the real income shock beginning in the U.K., it may be difficult for the country to avoid a recession. While the world globally faces higher inflation and slower growth, the situation is more pronounced in Europe given the continent’s reliance on Russian energy. Bessemer portfolios remain underweight the U.K. and Europe more broadly relative to benchmarks. A Bessemer All-Equity Portfolio has 6.4% exposure to Developed Europe relative to 15.5% for the benchmark and 2% exposure to the U.K. relative to 4% for the benchmark.
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