The Darkest Hour Is Likely Q1/22

02.09.2022: If economists are correct, the January Consumer Price Index (CPI), to be released on Thursday, will post its highest reading in 40 years. While we expect inflation to peak in Q1/22, and we anticipate growth and inflation readings to moderate toward pre-pandemic levels by the end of this year, we caution investors to brace for disquieting data in the meantime.

The environment appears ripe for spiraling prices. The job market is on fire: the January jobs report released last week showed employers hired 467,000 net new employees, exceeding all projections. The gain followed a 709,000 total upward revision to the prior two months, underscoring the need to hire workers to keep up with economic activity. This trend is remarkable against the backdrop of Omicron, the latest COVID variant keeping a good portion of the workforce sidelined. Moody’s Analytics estimates that nearly 12 million workers, or nearly nine per cent of the workforce, were absent from their jobs during the first 10 days of January due to sickness or caring for someone else who was sick. The Omicron-induced worker shortage has had a double-barreled impact on corporate America. First, it’s crimping growth. The Wall Street Journal recently reported that COVID-related worker shortages cut into operations at McDonald’s in Q4/21, forcing the fast-food giant to cut back store hours by about 10 per cent. Between December 27 and January 7, eight per cent of flights were canceled each day due to worker absenteeism, a trend confirmed by TSA checkpoint data.

Graph 1, Market Update, 02.09.2022

The second consequence of the worker shortage is showing up in higher wages, spurring investor fears of a wage-price spiral. The January jobs report showed average hourly wages grew by 5.7 per cent year over year, up from 4.9 per cent in December and outpacing economists’ expectations. Leisure & hospitality workers saw the largest gains, with wages increasing 13 per cent as restaurants and hotels vied for mask-wearing workers. Education and healthcare workers saw similar wage gains. Nonetheless, wage growth overall is not keeping pace with inflation, which the Bureau of Labor Statistics attributed to a cost-of-living increase of 5.9 per cent. That differential explains the deterioration in both consumer confidence and spending.

Graph 2, Market Update, 02.09.2022

With wages on the rise, businesses are fighting back – not with layoffs, but with increases in labor-saving capital investments. Higher business investments have spawned a productivity renaissance. US labor productivity soared to an annualized 6.6 per cent rate in Q4/21, double the rate expected by Wall Street. Productivity gains allow companies to raise wages without feeding inflation or crimping profits.  Labor costs adjusted for productivity gains, or the Employment Cost Index (ECI), are up four per cent, still high by historical standards but substantially below the nearly six per cent wage gain over the last year. Higher productivity should give the Fed additional breathing room in combatting inflation this year.

Graph 3, Market Update, 02.09.2022

Investors should buckle their seatbelts in preparation for some near-term inflation turbulence, but we believe smoother sailing lies ahead beyond Q1 as inflationary forces moderate.

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From Chief Investment Officer, Jack Ablin.
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