The euro’s two decade roundtrip to nowhere
Plus, US June jobs, CPI and what it means for the RBA
US June non-farm payrolls came in at 372k, which was close to our model’s forecast of 363k, and above the market’s expectation for a 263k increase. The unemployment rate came in steady at 3.6%, in line with our own and also the market expectation. The level of payrolls employment remains 524k short of its pre-pandemic level. By contrast, the household survey showed a fall in employment of 315k, contributing to the steady unemployment rate (the US unemployment rate is calculated based on the household rather than the establishment survey).
The US June CPI came in well above expectations at an annual rate of 9.1%, the highest since November 1981. The Cleveland Fed’s trimmed mean came in 0.8% on the month and 6.9% at an annual rate, which is the highest in the history of the series dating back to January 1983. This allows us to update our model for the Australian Q2 trimmed mean inflation rate to be released on 27 July. The model is calling it at 1.6% q/q and 4.8% y/y, up from the 1.5% q/q forecast based on the first two US inflation prints for Q2. This is in contrast to the RBA’s May Statement on Monetary Policy forecast of 4.5% for the year to June and 4.6% for the year to the December, although Governor Lowe has already effectively revised the forecast for year-end to around 7%.
This week also saw the release of the June jobs number for Australia, with the unemployment rate falling to a new cycle low of 3.5%, the lowest since August 1974. The employment-to-population ratio and participation rates rose to new record highs. The only weak part of the report was that hours worked were flat, with many people off work with COVID or the flu, but that only further contributes to the labour shortages that are now very evident to everyone in their day-to-day interactions. The RBA’s May forecasts had the unemployment rate still at 3.6% in the June quarter 2024!
Whereas the RBA was previously a cheerleader for a lower unemployment rate and looked forward to stronger wages growth on the back of a tighter labour market, it will now view both as increasingly problematic (I will update the wages forecast next week). The signal to policymakers from these data should be that they urgently need to liberate the supply-side of the economy to accommodate the post-pandemic expansion. Instead, monetary policy is going to have to trim demand to meet supply-side constraints. Migration inflows is one supply-side lever that could in-principle be pulled very quickly, but as things stands, the Australian government can barely keep pace with passport applications from Australian citizens, much less process inbound visas in a timely fashion. This year’s graduate intake into the Department of Foreign Affairs has been assigned to passport processing apparently.
Governor Lowe is speaking to the Australian Strategic Business Forum on 20 July and it would not be surprising if he dropped elements of the expected August Statement on Monetary Policy forecast revisions into that speech, along with some framing of the August Board meeting decision. Market expectations for the August Board meeting are being revised up, with many observers now expecting a 75 basis points tightening, especially after the BoC went the full century. However, the higher frequency for RBA Board meetings means the Board can stick to another 50 basis point tightening while still maintaining a similar tightening tempo to other central banks.
Returning to the US data, markets are struggling with the apparent disconnect between the US labour market and other activity data. Jason Furman and Wilson Powell note that ‘The disconnect between falling output and rising employment in the data for the first half of 2022 is larger than anything that has been recorded in the post-World War II period.’ Menzie Chin helpfully illustrates the disconnect with respect to both the Q1 GDP print and the Atlanta Fed’s GDP nowcast for Q2
One way in which the disconnect might be resolved, or at least narrowed, is through upward revisions to GDP, although the US is hardly alone in experiencing a negative GDP print in Q1. Potential mismeasurement is a separate issue, although one that could also prompt subsequent revisions. Years ago, there was a disconnect between the Australian GDP and labour market data, with the RBA telling the ABS the labour market data must wrong. The RBA proved to be correct on that occasion.
The vibecession
Recession risks are otherwise reflected more in the survey and sentiment-based rather than the real data. This in turn reflects concerns that the Fed will overdo its tightening cycle. Every bit of data that prints stronger than expected amplifies this disconnect between the soft and hard data. As Scott Sumner has argued, the Fed has not adequately defined its policy regime, which makes questions about current stance of its policy instruments somewhat moot. In the absence of a well-defined policy regime, the Fed is just feeling its way, with no natural stopping point that would condition expectations for an end to the tightening cycle. As Taylor Shiroff notes, ‘the Fed’s current “play it by ear” forward guidance style all but guarantees that they go too far. There is no known “stopping” or “slowing” indicator for future hikes, and the Fed seems set on using lagged indicators to determine policy.’ Shiroff’s post has a nice discussion about how the failure to anchor expectations for nominal income risks a recession.
This is unfortunate, because the Fed’s long-term strategy review landed on a reasonably well-defined policy regime. The Fed has simply failed to operationalise that regime in a way that anchors expectations for the policy rate. A good test of whether the Fed and other central banks are overdoing it is to track the divergence between nominal and real indicators. If nominal indicators are rising and real indicators falling, that is a good sign that we are being hit with supply shocks, at least on net, increasing the risk monetary policy will err in responding to inflation pressures. Expectations for nominal income bring the nominal and real sides together as a composite indicator. The Mercatus NGDP gap should be getting more attention than it does.
Parity party
The strength in the US dollar is symptomatic of the tightening in US monetary conditions, driving the US dollar to parity with the euro. While I have always argued against the notion that the US dollar exchange rate should be viewed as a barometer of the US dollar’s structural role in the world economy, the US dollar rally nonetheless goes a long way to invalidating the doomsday cult-like predictions for the US dollar’s demise among a certain class of macro pundits and hedgies. This rather amusing official rationalisation of EUR weakness could have just have easily come from a Bitcoin bro rationalising crypto weakness:
The ECB released its 21st annual review of the international role of the euro last month. The report confirmed the role of the euro in global capital markets tapped out on a constant exchange rate basis in the early 2000s and has been on a round trip to nowhere over its lifetime:
As I argued earlier in the year, the crypto rout was in many ways an early predictor of the subsequent dislocations in financial markets more broadly. Crypto’s status as a risky asset on the fringes of global capital markets meant that BTC-USD would be among the early casualties of US dollar monetary tightening. Those economies vulnerable to international spillovers from USD strength are just the next in line.
ICYMI
This must be the most strained bull case for China ever written.
Good news from Scott Sumner: ‘I am currently working on a book that will make the case for a truly “general theory”, a monetary theory that explains monetary policy in both Japan and Zimbabwe.’
Foreign direct investment in the United States enjoys a post-Trump/post-pandemic rebound:
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