Heads I Win, Tails I Win

Steve Sosnick, IBKR’s Chief Strategist and Jose Torres, the firm’s Senior Economist, discuss the market’s reaction to last week’s Payrolls report and how this week’s CPI report and FOMC meeting might influence interest rate policy over the coming months.

Summary – IBKR Podcasts Ep. 165

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Steve Sosnick:

Hi everybody This is Steve Sosnick, Chief Strategist here at Interactive Brokers, and welcome to IBKR podcasts.  This is the latest in our series of economic podcasts that I do with my colleague, Jose Torres, our Senior Economist. Hi, Jose.

Jose Torres:

Hi Steve, great to be here.

Steve Sosnick:

Great to see you too. Let's jump right into it, Jose. We have a very consequential week this week. We had jobs numbers on Friday, which I'd like to discuss first, but also then I'd like to look ahead to PPI, CPI, and of course, the FOMC meeting that's on Wednesday.

So first, could give us a look back on your take on the jobs numbers, please.

Jose Torres:

Sure. The U. S. economy added 272,000 jobs last month, trouncing expectations of just 185,000 and accelerating from the previous month's 165,000. Now, job growth did feature a non-cyclical tilt. Almost half of the jobs added came from government, healthcare and education. Among the cyclical sectors however, we did see some progress in leisure and hospitality, construction, as well as professional and business services. So, we had a broad-based growth across all segments, ex mining and information.

The blockbuster job growth also was accompanied with robust wage pressures, 0.4% above the 0.3% expected and exceeding the previous month's 0.2%. So, the establishment part of the survey — remember with the jobs report, you have the establishment survey and the household survey — the establishment survey looked really strong.  The household survey, on the other hand, was a little weaker. We saw the unemployment rate tick up from 3.9% to 4%. We saw labor force participation tick down 20 basis points to 62.5% because a quarter of a million people left the labor force. That means they are not looking for jobs and they don't have jobs at the moment.

Overall, there's evidence there for both the hawks and the doves, but the market responded by sending yields higher.  But stocks, Steve, you know, they remain resilient, they seem to do pretty well. Finally, it appears that when we have a hotter than expected economic report, investors look ahead to strengthening earnings prospects, and when we have a weaker than expected economic data figure investors look ahead to more liquidity from the Fed.

Steve Sosnick:

Heads I win, tails I win, basically. I mean, the stronger economic picture, I'm okay with that.  When we came into the year, we had this discussion about whether you can have an economy that's good enough to support the earnings growth that the market was expecting and have six or seven rate cuts.

And the answer to that was no, they're mutually exclusive. And I guess the good thing for equity investors was as the rate cut expectations began to get priced out it was for the right reasons, because the economy was solid. Now it's not so clear to me that we're going to get it both ways, but as we cut through those job numbers who do we believe?

Obviously, the bond market believes the stronger payrolls number. The equity market, I'm not sure what it believes. I think it was just sort of like, okay, Nvidia's splitting on Monday [the day this was taped] and Apple's got its worldwide developers conference. So, let's just continue onward.  It was a very mixed picture from there although most stocks, by the way, were lower. Who do you take as being more accurate? The households or the payrolls?

Jose Torres:

Well, Steve, I think at this juncture we have to look at both, but the Fed is always going to allocate more weight to the establishment survey because when we talk about a survey to firms and questions to households, we are covering hard data that comes in on spreadsheets versus soft data that comes in over the telephone, email response, or sometimes federal employees knocking on doors of households to ask questions. So, the accuracy of the Establishment Survey has been touted as being much stronger than the Household Survey for that reason.

Households, sometimes, they react with emotions, depending on which side of the bed they wake up on. Sometimes, particularly this year, there's more political feelings out there and sentiments. Other times survey respondents maybe want to represent a stronger or weaker version of themselves in the survey sample. So those are some dynamics as to why the establishment survey has more weight than the household survey.

And finally, we did see ISM services pick up pretty remarkably after we saw April data, retail sales mainly and personal income and outlays. Many of the pundits on Wall Street came out immediately calling for rate cuts. I let everyone know, including Bloomberg and Yahoo Finance, that just because we had one month of softening consumer spending, it doesn't mean it's going to continue.

Finally, throughout this cycle, we've seen the consumer take a break one month only to return the next. And I'm afraid that that's what we're seeing in May, and we can see inflationary pressures remain sticky here between 3 and 4%.

Steve Sosnick:

I'm a little envious that you got to discuss macro stuff rather than just GameStop, which was basically my week. So, as we get into the current week, let's start with the inflation figures that we're expecting: PPI, CPI. CPI is very interesting because it comes out the morning of the FOMC meeting. To the best of your knowledge, does the FOMC see that number beforehand? Even so, they'll be able to take it into account as they deliberate in the afternoon. How do you feel these numbers might shape the dialogue that occurs at the FOMC meeting?

Jose Torres:

You know what, Steve? I am a little afraid about too much weight being thrown on this week's number because this week's number is going to be the first month where inflation on a month-over-month basis actually moves in line with the Fed's 2% objective on an annualized basis. And the standard there is 16.6 bps month over month, which gets you to 2% over 12 months. So, we're probably going to get a number of consensuses around 0.2%. I actually think we're going to come in a little under; we're going to come in at 0.1% but it's not really due to services or goods prices cratering. It's really all about oil. Last month that went down roughly 6.5%, and that comprises a decent amount of the index, but services are going to stay problematic.

Rents are not coming down as much, even as folks keep saying rents are going to cooperate. They're just not.  Every month we're seeing all-time high prices in housing. With housing there are four components.  There's new homes, existing homes, new rents, and lease renewals,. And the only areas there that are really cooling off are new homes and new rents. Existing homes and lease renewals are not cooling off. We're going to keep seeing shelter, keep inflation above where the Fed wants it.

Steve Sosnick:

And to some extent, should we then be watching the core, or do you think that the headline is going to get all the attention?

Jose Torres:

You know, in this kind of market, Steve, it appears that folks close their ears whenever bad information comes, but when we have a good headline number, we focus on that. To the point that you made last week, I forgot which venue because there's been so many, but you said that usually it's safer to follow a trend than to call a turning point.

Thus, equity investors are probably going to take that report positively. But to your point, what are they going to say in the afternoon?  I'm more on the hawkish side, as you all know, ladies and gentlemen.  I'm hoping they say, okay, this is one report. We have to see more. That's what I'm hoping that they'll say and that'll probably keep September as a coin flip.

Finally, this is a huge report because we're also going to see the quarterly update to the summary of economic projections, also known as the dot plot. Last time in March, they expected three rate cuts. Now it appears they're going to expect either two to one. That's going to be top of mind for market participants, we'll see what happens.

Steve Sosnick:

My next point was going to be about the dot plot and the hawkish versus dovish concept. Correct me if I'm wrong, there’s a lot of rhetoric from, I'm going to call them the supporting cast members at the Fed, all of whom are very distinguished economists and practitioners. But, in my mind, the market only wants to hear from the lead actor, who of course is Chairman Powell, and he tends to skew dovish.  Even if he's trying to sound hawkish, he ends up saying something in there that has a dovish tone to it. Who do you feel really has the narrative at the FOMC? Is it the members who are pushing back on some of the Goldilocks scenarios that certainly the market has put in, and certainly that Powell doesn't necessarily rush to disavow? Do you think it really is sort of a Goldilocks scenario over at the Fed, despite some of the pushback that we get from some of the regional presidents?

Jose Torres:

No, I think things are getting quite tenuous in the boardroom. We saw Mester leave. We saw Bullard leave last year. We're seeing a bifurcation in what the folks in Washington think versus what the folks in the regions think.  In the regions, you tend to be closer to more of the regular households, more of the average businesses that are suffering. They're not economists or financial analysts or strategists like us. They don't see 2% or 3% or 3.5% inflation. When they go to establishments, they notice prices that they're paying, whether they're going to have dinner with their family, whether they're going to fly on an aircraft and expect their baggage to be on there and their carry-ons and all that, they're seeing that they're spending a lot more.

And what I think is occurring is that the folks in the regions, like Bostic, like Daly, a little bit also Williams in New York — he's been hawkish at times — Collins in Boston. They come out and they push back because what they're hearing from their district are folks and businesses alike suffering, whereas Washington, they focus more on the macro and what large cap firms are doing and not typically your average Joe on the street.

Steve Sosnick:

That is really the conundrum with inflation. I think Paul Krugman wrote a column recently about inflation truthers and people pushing back on the idea of inflation coming down. Still paying a lot of money, but it's a first derivative vs. second derivative thing. Inflation coming down still means that prices are going up — just more slowly than they had been — and I think that's difficult for people to process because I think they confuse disinflation with deflation, which are two different things. Obviously, as an economist, you wouldn't do that, but I think in the general public it happens.

I'm going to leave you one final lightning round question Jose. Is it possible that we don't get a unanimous statement from the FOMC?

Jose Torres:

It's certainly possible. We saw Chair Powell a few months ago say it's okay if we have distance, life goes on. Things in the boardroom are getting a little tense in terms of when it's time to cut rates. Some folks are worried that perhaps they opened the door too early back in December. We rallied off of [S&P 500] 4,100 because we were going to get rate cuts. We rallied from 4,700 because we weren't going to get rate cuts. Now we're here at 5,200, 5,300. We're rallying again for the original reason, because maybe rate cuts are right around the corner, you know? So, the market is just taking everything in stride. I do think we're going to see bifurcated responses from committee members when Chair Powell comes out.

Steve Sosnick:

I think we've just come up with the title for this podcast, which is “Heads I Win, Tails I Win” and, on that note, I'm going to thank my colleague, Jose Torres, our Senior Economist. I'm your host today, Steve Sosnick in lieu of Andrew Wilkinson, and thank you everybody for joining and I hope you enjoyed today's IBKR economic podcast.

Tune in again soon. Thank you. Bye.

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