The abnormalities in labor markets are not changing with rising rates

The current labor markets are not easily understood. The economy has been slowing down, yet unemployment is low, job growth is good, participation is still below pre-pandemic highs and quit rates are still high. 

Jobs are available, but there are segments of the market that are not going back to work or not happy with current jobs and quitting. McKinsey has referred to this as the Great Attrition. Despite the efforts of the Fed, labor has not significantly changed in response to rising interest rates.  

Perhaps workers are so used to an environment where it is easy to find new jobs that they do not fear quitting, but the workforce is not deeply engaged with employers. There is a disconnect on the causes and what employees and employers think are important for sticking with a job. 

Our fear is that this uncertainty or disconnect leads to false signals on link between policy, markets, and the real economy. What happens if quit rates are high but hiring slows quickly? There can a strong surprise increase in unemployment. Similarly, if quit rates slow, hiring will quickly fall. The likelihood for large labor dislocations is high.

Moving beyond a binary world - a slow speed of adjustment year in 2023

In the summer, we discussed the world being binary - inflation / no inflation; recession / no recession; geopolitical crisis / no crisis. The world threats were between extremes. See Global macro decision choices - A binary world? Now we are entering a new world that is not about binary choices but about the slow grind of reality versus expectations. Uncertainty is elevated and will stay elevated.

Inflation may have mixed rates around the world, but the focus is now on the grind lower for inflation not whether it will be present. It is being viewed as a speed of adjustment process. 

A recession is expected in 2023 by most market analysts. The focus is on how fast economies will grind lower. The stagnation is not about a strong or deep recession but focused on slow growth with a shallow recession. It is not a question of whether it will occur, but when and how deep.

Geopolitical risks such as war are now focused on the grind from stalemates and gridlock. Geopolitical risks will be with us for the year and not have easy solutions.

The energy shock is now about dealing with lower temperatures and the fact that stocks will be depleted as we move through new year.  Energy shortages will be present even with natural gas and oil prices currently almost unchanged for the year. It is a matter of when and how bad. 

Policy choices were about strong inflation fighting or weak inflation fighting. Now we are about focused on terminal rates and length before loosening and how to smooth the effects of monetary policy.

Getting forecasts right or wrong were a big deal in 2022 because the cost of being wrong was so high. The forecasts of 2023 will be more subtle and take more work at getting right but the costs of being wrong may be less as speed of adjustments slow.

VUCA and VUCA prime - more on Volatility Uncertainty, Complexity and Ambiguity

Coach Lasso’s paradigm appears to be the personification of “VUCA Prime,” a countermeasure created by Bob Johansen. In his version, VUCA stands for “vision, understanding, clarity and agility.” Leaders like Ted Lasso who apply VUCA Prime can thrive and create opportunities for success instead of suffering from terminal paralysis by analysis. 

-"Commentary: How can we thrive in a VUCA environment?" Dayton Daily News 

We have been a strong advocate of using VUCA (Volatility, Uncertainty, Complexity, and Ambiguity) as a guiding framework for discussion concerning the investment environment. The world can have more or less VUCA, but you will always have to deal with the four factors. The VUCA prime concept attempts to address how an investor should behave to offset the problems of VUCA. 

Vision is not just strategy but seeing the environment for what it is, good or bad. 

Understanding attempts to make sense of the world even if it is confusing. 

Clarity is what an investor strives for, although it is not clear whether it can be achieved.

Agility is how you need to behave in a VUCA environment. VUCA means that any investor may need to quickly change and adapt to the market. 

Being a successful trader or investor is not about being a better predictor but being better at dealing with the things we do not know, and the complexity of the environment faced. The best strategy may be to walk-away and hold cash given the level of uncertainty faced.

(See Living in a VUCA world - This is the core problem for investors.)

There is more than one way to measure inflation

 

Inflation is starting to come down, but there is a lot in the inflation numbers that we just take for granted or that we do not think about. For example, if we use the shadow stats which calculates inflation using the basket devised in 1980, we will much higher inflation. In fact, inflation will be at the highest levels recorded. 

A new paper shows the deviation of the adjusted core inflation versus the real Fed funds rate is at the greatest levels ever recorded and similar to what we have seen in the 1970's. See "Comparing Past and Present Inflation". This paper uses the current methodology and applies it back in time to find that the current inflation peaks are closer to past inflation peaks than the official series would suggest. The official series makes adjustment along the way. The Volcker era rate of disinflation is significantly lower because the peak was never as high.

This data can lead to several interpretations. One, the 1970's inflation was not as high as official reports. Two, the current inflation is more dramatic than believed when compared with a similar methodology. Three, to get the same decline in inflation may require more draconian Fed policy action. Four, the size of the current inflation mistake is more like the inflation mistakes of the 1970's.

The inflation problem is far from solved.