EXANTE Macro Insights

By Renée Friedman, PhD

The week in summary:

Welcome to the 4th in our Macro Insights series. Over the last week we’ve seen solid corporate results help counterbalance inflation concerns although investors are looking closely at how higher energy and raw material costs are affecting margins. The dollar was slightly weaker against its peers. Although it is becoming clearer from the Fed that the taper of the $120 billion monthly bond purchases will almost undoubtedly begin in November, a rate rise is, in the words of Fed Governor Christopher Waller on Tuesday 19 October, “probably still some time off.” On the other hand, in the UK, the Bank of England governor Andrew Bailey said, during a panel organised by the Group of 30 consultative group on Sunday 17 October, that although he continued to believe the recent jump in inflation would be temporary, he predicted that a surge in energy prices would push it higher and make its climb last longer, increasing the expectation of higher medium-term inflation. “And that’s why we at the Bank of England have signalled, and this is another such signal, that we will have to act,” he said. “ Meanwhile, global bond yields were mixed and oil prices held near multi-year peaks.

It’s certainly a tough time for central banks (and investors) as they grapple with rising inflation, the energy price surge, the secondary effects of supply constraints, increasing wages, and uncertainties around labour markets, skills mismatches and participation rates affecting longer term growth potential.

This past week saw a record high for bitcoin as it reached $66,722 on Wednesday. This is approximately a 130% increase in 2021. This was on the back of the new bitcoin ETF, Proshares ETF, which opened at $40.88 on Tuesday under the ticker BITO. This ETF is  investing in bitcoin futures not the actual digital coins. ETFs designed to own actual crypto assets are still not allowed by the Securities and Exchange Commission. Many crypto enthusiasts are hoping that bitcoin ETFs will soon be included within pension funds and other large investors portfolios. This would potentially reduce the high level of volatility associated with the asset as demand would be more stable. As noted by Bloomberg bitcoin has climbed to its latest high atop a tide of pandemic-era liquidity, speculative bets and expectations of wider adoption by institutional investors. On Tuesday BITCO was the second-most heavily traded fund on record with turnover of almost $1 billion.

Things to look out for this coming week:

• In Europe on Friday look out for Markit manufacturing, services and composite PMIs. On Tuesday the ECB will release its bank lending survey which will give a good view of financing conditions across the EU. On Thursday we will see consumer, services, industrial and business confidence numbers. The ECB rate decision will also be revealed on Thursday along with the monetary policy decision statement. 
• For the UK on Friday we will have retail sales, services PMI  and manufacturing PMIs 
• In the US on Friday we will see Markit services, manufacturing, and composite PMIs while on Monday the Chicago Fed National Activity Index (CFNAI) which should give an indication of overall economic activity and inflationary pressures. On Tuesday there is the Housing price index which is important as housing is a very sensitive indicator of the US economy. Wednesday is the most important data day in the US with the release of preliminary GDP for Q3.

The human factor behind the stagflation risk

Over the past week, following the release of the FOMC minutes, it is clear that the US Fed’s team of economists think inflation will come down to below the targeted 2% in 2022 while market economists think and are reacting otherwise. So who is right? Will the market overshoot as it often does or will the Fed’s forecasters, with their wide band of scenarios, be right?  Economists often get it wrong and we disagree with each other incessantly about why,only to realise, with hindsight, that another factor was coming into play. This is exemplified by Queen Elizabeth’s question about the global financial crisis to a group of professors at the London School of Economics and Political Science in November 2008, “why did no one see this coming?” (and yes, as an LSE alum I still cringe every time I think about this). 

Perhaps the factor that is coming into play that maybe should garner more attention is labour market dysfunctionality, i.e. the skills and educational access gap that exists that may be preventing workers from either re-entering the workforce post-Covid or in entering it to begin with.  In the US on Wednesday 19 October, the Beige book, a summary from the Fed's 12 regional districts, showed that although employment was increasing, labour growth was dampened by a low supply of workers. This was despite wage increases designed to attract new hires and keep existing employees, the report said.  Competition for talent and workers' willingness to switch jobs is driving up wages.  This is not just a US problem; wages are increasing globally. As reported by the Financial Times on Thursday 21 October, “wage disputes are becoming a flashpoint for investors and policymakers as developed economies recover from the pandemic. Emboldened by staff shortages, rising energy prices and living costs, employees are increasingly butting heads with their employers over salaries. One of Germany’s biggest trade unions this month asked for an inflation-busting 5.3 per cent pay rise.” 

Yet, more worryingly, the US report showed that the increase in available workers that was expected as pandemic unemployment benefits expired and schools reopened failed to materialize in many districts. Given that pandemic related employment support has been largely removed in the US, the UK and in Europe we would expect unemployment to fall. It largely is, but why are we still seeing lower participation rates than would be expected? The UK, for example, has seen its highest ever number of job vacancies in July to September 2021 at 1,102,000, an increase of 318,000 from its pre-pandemic (January to March 2020) level. However, the economic inactivity rate was estimated by the Office for National Statistics at 21.1% in September 2021, 0.9 percentage points higher than before the pandemic.  Even though European unemployment has fallen back towards pre-pandemic levels and the number of people on state job support schemes has dropped sharply, labour shortages remain there throughout, especially among younger workers. 

Has the pandemic made people less willing to work jobs they don’t love or is it something else? It seems that it is really a (global) structural unemployment problem that has been largely ignored by markets prior to the pandemic. The skills gap and the associated bottlenecks and inflationary effects it may have, may well become the factor to cause a slowdown of the post pandemic recovery and lead to medium term stagnation. 

Although much attention has been paid to the shortage of HGV drivers, fruit pickers, hotel and other frontline service staff, the results of the OECD report published in September 2021 on the job market, the Employment Outlook 2021, points out how a slow rebound in jobs involves a high risk of long-term unemployment. It stressed the need for governments to invest in up-skilling and re-skilling of unemployed and displaced workers. It said this was a fundamental  action to support job transition in the recovery, and respond to changes in the demand for skills brought by automation, digitalisation and structural changes. 

It is clear that in the short term, governments will need to step in – whether by deploying soldiers to be HGV drivers or providing subsidies to companies to hire seasonal workers to prevent further inflation spikes in food and in retail services and to mitigate some of the shortages and keep the economy from slowing. In the meanwhile Central banks will have to cautiously deal with the secondary effects of supply constraints and rising commodity prices by keeping a solid eye on inflation anchoring.  Although we are highly unlikely to have significant wage inflation spirals, largely due to the fact that labour markets  themselves have changed so much since the 1970s, it does not mean that stock markets will be immune.  In fact, stock markets may come off their highs as we move further into Q4 and into early 2022 because of this structural unemployment problem really coming to the fore. 

The pressing question for companies and policy makers will then likely become, how, once immediate supply concerns abate, should they think about the  kind of insurance or slack they should build into educational and employee training systems over the longer term to mitigate any future supply side shocks. 

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