Jobs, housing, QT, and the Red Sea. Listen as macro analyst Richard de Chazal examines the current economic indicators, provides context around the potential end to QT, and offers his perspective on a possible Fed pivot, in the first Monthly Macro episode of the year.

Podcast Transcript

00:00: - 00:314
Chris Thonis
We are kicking off the first monthly macro episode of 2024 with macro analyst Richard de Chazal. He joins me to discuss the latest data releases, including employment, inflation, and housing. And of course, we'll also touch on the latest Fed news. Ali, since the last episode, since Powell recently pivoted on rates as well as a potential and to Q2. So with that, Richard, thank you for joining me. Take this off. Let's talk a little bit about the employment data, which yet again seem to come in hotter than what was expected in one of your recent reports, you mentioned that you thought it was a little weaker on the surface, but do you mind just fleshing out what you're thinking about the employment situation at the moment?

01:06 - 01:24
Richard de Chazal
Happy New Year. Great to be back. I think we've got quite a year ahead of us already. You know, ton of major elections coming through. Still, in my mind at least, the possibility of a recession, I think, still kind of hangs over us. And unfortunately, we're also seeing this kind of ratcheting up in geopolitical pressure. That's not great.

But yeah, on the plus side, I think as you mentioned, the employment data was pretty good. The data generally has still been resilient. So that's really encouraging. A lot of that really comes from the labor market. So, you know, it's the old saying where the consumer goes, so goes the economy. Given that they account for about 70% of GDP.

And of course, the main driver of that is the labor market. In the last employment report we saw, which was released a couple of weeks ago, yet again, we saw another above consensus increase in nonfarm payrolls. They rose by 216,000 jobs where the market was expecting 175. The unemployment rate stayed at 3.7%. It had been expected to increase to 3.8%.

And then average hourly earnings sort of ticked up a bit to 4.1%. You know, they'd been expected to stay at 3.8. So, on the surface, I think it's all, again, pretty robust stuff. If you scratch a little bit below that, we are, I think, seeing a little bit of signs of softening. And I think the bond market noticed that as well, because you didn't get quite as big a sell off when that data was announced as you might have seen, just based on the sort of headline data on that.

02:47 - 02:51
Chris T
And there was a spike originally, right? And then it came back down quickly.

Richard de C
Yeah. So I think I think it's sort of the bond market. You know, it gets the initial knee jerk reaction and then it sort of digs a little, you know, in some of the back pages and then sort of has a bit of a reassessment. If you look at, say, you know, the household survey and maybe it's good to remember that this report is divided up into two different surveys.

So there's a payroll survey which the BLS reports, and that's data from companies who submit data on actual employees on their payrolls. And then there's the household survey, which is the Bureau of Labor Statistics. You know, going out, knocking on doors and asking members of the public, you know, in their households who's working, who's not, how long have they been unemployed, are they actively seeking work and all that kind of stuff.

And that's the data that goes into calculating the unemployment rate, the participation rate and that kind of stuff. And over time, the two numbers should correlate quite strongly from one month to the next. They generally do. But you do get these divergences every now and then. And that's what we saw in December. So even though we got a pretty strong payroll number, the household survey actually showed a decline of 683,000 jobs.

So that's pretty substantial. If you also look at the number of people leaving the workforce, there was a rise of about 845,000 workers who classify themselves as not in the labor force, meaning they're not actually actively out there looking for work. And that's maybe because there are fewer job openings or because they're not getting paid enough or they're choosing to retire or go work in the military or go back to school.

Who knows? It could be a bunch of reasons, but because of that, drop the participation rate also came down. It was 62.8 and then it came down to 62.5, which is kind of a chunky drop for just one month. So maybe if we cast the net a little bit wider to some of the other employment data we're seeing, you know, we're still seeing incredibly low initial jobless claims, things still seem kind of glued to 200,000 per week, which is incredibly low.

But then the job openings data, those have been coming down quite quickly. So we've also seen this drop in the number of workers that are quitting their jobs. So normally you'd kind of quit to presumably go off and be employed in a kind of higher paying job elsewhere. So fewer people quitting their job would be associated with less churn in the labor force, that kind of thing.

And then also in the in the payroll data, we saw yet another month of declines in the number of temporary workers. So the number of workers doing temporary jobs. So that could be because they're going off and getting employed in full time jobs. But then if you actually look at the number of full-time jobs versus part time jobs as a share of total employment, that share has actually been coming down quite significantly.

So, again, a bit of softness there. If you look at multiple job holders, those numbers have been pushing upwards, which is again, a sign of a little bit more stress for the consumer. I guess my point is generally that the numbers are still pretty decent, but growth is decelerating a bit. And while we're not actually seeing much in the way of layoffs, just yet, there's a little bit of softening.

So I guess more generally, we could probably still describe this as fairly Goldilocks type data.

06:47 - 07:05
Chris T
We just had a fresh batch of inflation data with the CPI. Was it last week, a couple of weeks ago in the CPI as well? Inflation still seems to be heading to 2% by the end of the year. The wage growth in the last employment report, as you somewhat mentioned, I think was something the market clearly noticed as being a little higher.

Do you mind just touching on that a little bit?

07:07 - 07:36
Richard de C
It's still a good news story here. We're still heading in the right direction. But I think the concern here is that the pathway from here, so 4% inflation to 2% might not be quite as smooth as the market sort of is expecting it to be. And I think on the wages side, the truth is we actually haven't seen all that much in the way of wage costs pushing up inflation.

So real average hourly earnings only turned positive in about the middle of last year. So wages for the most part have really been following inflation and not really driving it much. But that's something that had been worrying the Fed. Are we going to start to see that as kind of a next level factor kicking in and keeping inflation higher?

I think the fact that it's been coming down quite steadily has really reduced that concern quite a bit. But more recently, I think the debate has reemerged this sort of transitory versus sticky debate where the transitory camp is now claiming victory once again in the sticky camp and saying, well, hang on a minute, that battle's not quite over just yet.

And that's this kind of battle over the last mile, as it's called, on inflation. What kind of factors are we seeing that could potentially sort of bump that around? One of them, I think, is if corporate profit margins are now starting to come under a little bit more pressure, companies could be more reluctant to lower their selling prices, say in line with what they're seeing on their wholesale prices coming through.

And so we're actually seeing a bit of a wide gap between the growth rate on producer prices and the pace of growth on consumer prices. Producer prices actually came down pretty rapidly in the last report. They're just now 1% year over year annual, 1.8% on the core rate. But there's been a much slower pass through from those to the end consumer.

So that's great for protecting margins, not so great for the consumer and the Fed. And in the latest CPI, we saw the inflation rate actually increase to 3.4%. It had been expected again to fall to 3.2 and the core rate was expected to go 3.8. It'll come down to 3.9. It's not terrible, but definitely less than expected.

And I think overall, the key here for the CPI, you know, how we get to that 2%, we still know that shelter is pretty much the biggest component of the CPI, about 30% of that basket. And we also know that the way the BLS calculates these prices is that those shelter prices really lag what's happening in the real world, say, real world rental prices, by about a year.

We know in the coming 12 months there's still a lot of disinflation in the pipeline that's going to come through. So that's encouraging. But I think it's just these other factors that might throw a little bit of volatility into the works in finally getting there.

10:43 - 11:04
Chris T
And you say other factors. I imagine that the disruption in supply chains is another factor that we have to be watching with what's happening in the Red Sea. The Houthis disruption of that supply chain. Do you have any thoughts on that area right now? I know that that's kind of a big worry for a lot of people.

11:04 - 11:18
Richard de C
Yeah, I mean, clearly it's not great. This is probably some sort of proxy war with Iran already emerging. I think we can all draw up some uncomfortable geopolitical scenarios we'd rather not think about.

So from one perspective, this is a geopolitical risk to inflation. And those are clearly more elevated. What does it mean for the inflation data? I mean, I think I recently read what we're seeing now in the red Sea is that about 80% of the ships are still getting through the Suez Canal. If you're flagged as a Chinese container ship, you're probably not going to have much problem getting through if you're [from the] UK, European or U.S., you're clearly more at risk.

So, it seems like about 20% of the ships are choosing to go around the Cape of Good Hope that round trip save from Shanghai to Rotterdam, is adding about 13,000 kilometers to the journey. So that's more time, more energy, more money. And I guess the other thing is that it's not just the Red Sea or the Suez Canal that's being impacted.

We're also seeing reduced traffic going through the Panama Canal as well. And that's not because of geopolitical issues. That's because of climate change issues where you're seeing reduced water levels, which is reducing the number of ships that can pass through.

Chris T
That's right.

Richard de C
Now. So yeah, again, that's adding more delays, more costs, container shipping prices. So again, to go from, say, Shanghai to Rotterdam the year-on-year change there is up 133% and even from Shanghai to L.A. so that doesn't go through Suez, those prices have increased by about 3%. So then you've got this combination of factors once again disrupting supply chains, you've got the geopolitical factors.

Hopefully they're mostly temporary, but you know, we'll see. That is clearly going to be encouraging more reshoring or near shoring, probably a bit more capex spending on the back of that. But then you've also got this kind of perfect example of how climate change is once again pushing up and disrupting our lives. So, I think probably both are just another reason why we're no longer in this world where just about every possible global driver was disinflationary, say, before COVID.

I think what we're seeing now is that things are a bit more mixed. We've got some drivers like innovation and age and all that kind of stuff, which is clearly still very disinflationary. But we also have some more inflationary ones coming through, which I think ultimately means that, you know, we can still be at 2%, but maybe the volatility around that might be a little bit higher than what it has been in the last couple of decades.

14:19 - 14:32
Chris T
So moving on, you recently wrote about the housing market and the thought that we're probably moving back towards buyer's market compared to what's been a seller's market for the last year or two. But do you mind just elaborating on that area a little bit?

14:32 - 14:51
Richard de C
It has been a seller's market for the last couple of years since COVID. I mean, how else do you explain mortgage rates jumping from two to 3% to 8% and then you still get this massive outperformance in the S&P Homebuilders index, right.

Chris T
Not to mention no price came down. All the home prices stayed the same.

Richard de C
Yeah. I mean, yes, it's been a crazy. If you told me that prices mortgage rates are going to jump to 8%, I would not be a heavy buyer of the right.

Chris T
So. Yeah, right.

Richard de C
But I think the narrative…it's a pretty simple supply and demand story. Their demand has been consistently pretty strong because of the shift from COVID working from home, the strong labor market, that kind of thing. But supply has been incredibly constrained and that's been again due to the supply chain problems and more recently because of the collapse of inventory for existing homes.

So those homeowners who saw mortgage rates go from two or 3% to 8%, they're not keen to sell their homes and jump up to that 8% rate. So they're hanging out, waiting and they're not bringing supply to the market. And I think that's what's been great for the homebuilders, because they've really been the only game in town. But I think in this coming year that's going to change.

So from probably two areas, one, maybe three one, we've got a massive amount of supply in the multifamily home area that's going to hit the market. Remember that during the COVID when the homebuilders were all missing their windows, lumber, steel trusses, all that kind of thing? It meant they could start at home, but they couldn't actually finish it.

So what they do is they started go off, start another one until they'd hit a roadblock, then go off and start another one and then come back and try and complete that one. When they actually got all that supplies coming through. But the problem is, is that they started a heck of a lot of multi-family homes and now there's a ton of those properties that our supply chains are clearing.

They're now starting to be completed and you're starting to see much more of that inventory. Three really flooding on to the market. So that's really a multifamily story. It's not so much a single-family story where you don't really have that problem, but I think it does mean that we're going to see a lot more downward pressure coming on.

The price is for those multifamily homes. And one other area I think you could potentially see more pressure coming through is on the commercial real estate side. So we've seen a bunch of pressure from private investors to own a lot of these multi-family dwellings. They're seeing some rising delinquency rates. They're seeing interest rates that have gone up. They could also be wanting to push more supply onto the market.

And I guess the final thing is those existing homeowners, they can really stay on the sidelines forever. If we start to see unemployment starting to push up, there'll be more pressure on them to sell their homes if delinquency rates are rising or if they're moving cities because of jobs, all that kind of stuff, there's going to be more supply gradually coming on to the market.

So, again, I think we'll see more pressure on price and we'll probably see more supply coming back onto the market.

18:22 - 18:44
Chris T
Okay. Interesting. So turning to the Fed, there's been a few new news items here since we last spoke and since the last FOMC meeting, the first Powell came out and seems to have clearly pivoted on rates. I would love to know from your perspective, was that a real pivot and was it as dovish as the market seemed to interpret it?

I know a few of the Fed had to come out after the meeting and backtrack a bit on his comments, but would love your perspective.

18:50 - 19:19
Richard de C
I have to say I was a little surprised at, I guess, the dovish ness of Powell's pivot. I mean, my feeling going into that FOMC meeting, I think the narrative had been, you know, the Fed's going to come out, it's going to tell us rates have peaked. They're thinking about cutting rates in 2024. Going into that meeting, there had been a pretty steady decline in financial conditions or an easing in financial conditions.

Indices in expectation of those future rate cuts. And if those are the transmission mechanism for Fed policy, if the market is already doing the easing ahead of actual cuts, then kind of by definition, the Fed sort of does less. So I thought what we would see was Powell looking at that and then kind of pushing back on those rate cuts a little bit and maybe talking about financial conditions.

But that's not really what we got. Instead, we had Powell signaling that the peak in rates was in, but he didn't really seem to kind of try and rein back the market on those expectations. And then, I guess, unsurprising me or I don't know if unsurprisingly, but then we did get, as you say in the next couple of days, a few of the Fed heads like Williams coming out and sort of pushing back a little bit more on that.

But then the market kind of listened to Williams and really just brushed him off, sort of laughed him off. More recently, we've had Waller was speaking, he's pushed back a little bit, but basically saying that if inflation is coming down again, rates should be similarly coming down as well. So, I think what we've actually seen is rather than the Fed kind of pushing back, what we've seen in the last couple of weeks is actually the economic data itself, which has been much stronger, so that employment data, the inflation data, a little bit more robust.

We just saw some pretty robust retail sales data. That's what's kind of forcing the market to rethink rather than perhaps the Fed has been saying.

21:09 - 21:37
Chris T
interesting, I didn't think about that. All right. So two minutes to that meeting and a recent speech by Dallas Fed President Lorie Logan, they revealed that the Fed is now starting to think about slowing the pace of QT and then the size of its balance sheet that at the same time the Fed's balance sheet has only been reduced by $1.2 trillion, which I believe is from$ 8.9 trillion at the height of the pandemic to $7.6 trillion today before the pandemic in 2018, it was $4 trillion.

Chris T
So feels like we still have a long way to go before getting back to the pre-pandemic size. The balance sheet. All that said, why is the Fed talking about this already?

Richard de C
Good question. I mean, it does seem crazy that from 2019 to 2022, the Fed's balance sheet expands by basically $5 trillion. They've only shrunk it by 1.2, and they're already talking about ending cut. Given all the cuts, you know, all the conspiracy theories in the market around the Fed's balance sheet, I'm sure a lot of those conspiracy theorists are really frothing at the mouth right now on this news.

So what's actually happening is a little bit of background I think here is probably useful. But without getting too technical, I think what's really important is to note that the Fed made some significant changes to way to the way it operates monetary policy back in the global financial crisis in 2008, which was when Bernanke went to Congress and asked for permission or the power to pay interest rates on the reserves that banks hold at the Fed.

So pre-2008, the Fed didn't pay any interest rate. So you were forced to hold reserves at the Fed as a bank for precautionary reasons. But the Fed didn't pay you anything on those reserves. It's kind of a penalty to holding those reserves. So unsurprisingly, there was zero incentive to hold any excess reserves any more than you had to at the Fed.

And basically, what banks would do would they'd go and lend those excess reserves amongst each other, and you would pay the interbank lending rate for those reserves, which is the Fed funds rate, but then got it when QE started and the Fed's buying bonds from the market, it then has to pay for those bonds and it credits those banks with reserves that they're held at the Fed.

It's kind of creating this thin air money. And the banks ended up being stuck with a ton of excess reserves. So to prevent those from flooding out into the market and not being able to keep the Fed funds rate that interbank lending rate from falling to zero and staying there, the Fed had to pay an interest rate on those reserves to kind of lock them on to their balance sheet.

After all, why would you go and lend to another bank? You are those reserves when the Fed is paying you X percent risk free to park it there. So basically that's what the Fed did. But what that crucially did is it also changed the way the Fed manages monetary policy. So it separated the size of the Fed's balance sheet from monetary policy decisions.

So having a large balance sheet didn't necessarily mean or doesn't necessarily mean that policy was extremely loose or relatively easy. Right. So the Fed is saying the way of gauging that is through the interest rate that is paying on those reserves, which is still kind of gauged off of the Fed funds rate. So it doesn't really tell you the size of the Fed's balance sheet, doesn't really tell you about anything to do with easing or that kind of thing. Right? so…

Chris T
Got it.

Richard de C
Yeah, that's how we should think about that a little bit when we're starting to think about cute because that's how the Fed thinks about that. And the only problem with this new kind of system of the Fed having a very large balance sheet and adopting this so-called floor system for managing interest rates, is that in order to for this system to work, the Fed needs to have a lot of reserves on its balance sheet.

And that causes it needs to have abundant reserves or ample enough reserves for this system to work. The problem is that we don't actually know how much is enough. What is ample amount of reserves actually mean. There's no fixed or set amount. So that's the problem, is the Fed doesn't really know when it's doing duty, reducing the size of its balance sheet, how much is actually enough.

And I think what we saw the last time the Fed was reducing its balance sheet back in 2019. One way of finding out is basically if something bad happens. And that was what we saw in 2019 when we had this kind of repo madness event where all of a sudden interest rates in the repo market.

Remember? That's right. That's just the interest rate that financial institutions basically charge each other to borrow cash. That's collateralized overnight in this market. And those rates suddenly spiked up to like 10%, which was a bit weird. I think that was clearly a sign that balance sheet reduction had gone too far. That liquidity was drying up. And that's the kind of thing I think the Fed wants to prevent, because that then has implications which then feed through to other parts of the market and eventually would feed through to the equity market.

So I think, you know, it's clearly important to know when those reserves are getting too low, when liquidity is becoming more scarce, and when we're going to start to see potential for those problems to emerge. And effectively what the Fed is doing is kind of feeling around in the dark here. It doesn't want to just sit and wait for something bad to happen.

It needs to look at what the market is telling us. And I think what the market is telling us at the moment is that we are starting to see a little bit more volatility emerging in these interbank rates. So things like the SOFR rate, the secured overnight financing rate or those repo rate, but maybe not quite enough just yet to suggest that anything major is emerging.

That's it's just starting to suggest that liquidity is getting a little bit tighter. And I think that's what Laurie Logan, who used to be the head of the desk managing the Fed's balance sheet at the New York Fed, so pretty important role. And she actually clearly knows very much what she's talking about. So in the speech recently [she] started saying, well, that she's starting to see some movement here, some indications that liquidity is getting a bit tighter and that it would probably be a good idea to maybe just start to taper the QE drawdown going forward in the coming months.

So it doesn't actually become a major problem. And I think the other point that she made when it comes to reserves is not all banks are equal. In fact, the reserves market is heavily skewed with some banks actually, just a few holding the vast majority of those reserves and the rest kind of holding far fewer. And I think what we also know is that it often only takes just one bank to have a bit of a problem before that could set in motion a whole stream of sort of cascading problems across the financial system.

So clearly something we'd want to avoid. So I think, you know, the answer is we need to pay very close attention to what those market rates are telling us. Pay very close attention to what the banks are telling us. The Fed does biannual and quarterly surveys of the banks watch also the standing repo facility, which is what the Fed set up after 2019.

That repo event, which is basically like the sort of the new discount window where the Fed can act as lender of last resort to these other financial institutions who may not have access to the discount window. It can sort of lend to them. What are we seeing in terms of activity there? And I think Logan is looking at all this and saying it's at least time to start thinking about having a discussion out there.

Let's see what financial market parties’ opponents have to say about this and let's not wait until something breaks. I think this is now where we are and something we should be starting to hear a lot more discussion about in the upcoming months in Fed speeches and the various FOMC meetings.

31:13 - 31:27
Chris T
I know everybody's eyes are going to be on this stuff for sure. So. Okay. Well, Richard, we need to wrap this up. Obviously, love these chats. So thank you again for joining. Hope we are in touch again soon, I guess next month. And that's it. So goodbye.

Richard de C
Always a pleasure. Thanks, Chris. Take care.