Substantially More Jobs, Lower Unemployment and Higher Gold Prices: Odd?

May 15 2019

Last month, the number of newly created jobs in the U.S. came in far above the expected 263,000. Analysts were expecting an increase of approximately 180,000 jobs. Simply put, whenever the number of newly created jobs is higher than what the market expected, a type of Pavlovian reaction occurs in which markets expect the odds of tighter – that is, less loose – monetary policy to increase as well. Especially when investors, shortly before that, were told that economic growth also came in higher than what those very same analysts expected beforehand.

The outlook for tighter monetary policy generally means that gold prices will fall. However, the exact opposite happened today: gold prices rose by a couple of dollars after the most recent data on the U.S. labor market was published.

Odd? At first glance, yes. But when we take a closer look, there are actually some good reasons behind the rise in gold prices.

There is little reason to fear that the Fed will begin to hint at higher interest rates anytime soon. Compared to a year ago, wages have risen by 3.2 percent. I would call that a perfect percentage. Wages are, after all, increasing at a pace slightly above the rate of inflation, such that there is a modest but noticeable rise in the purchasing power of households, which bodes well for the economic outlook in the short run. At the same time, the rise in wages is, however, not significant enough to sound the alarm bells at the Fed, with no reason to expect wages to push up inflation in the mid-long term. In other words: markets do not have to worry about a Fed hinting at resuming its rate hikes. Moreover, the recently published numbers are – to me – not a reason to expect that the Fed will opt for anything else than lowering interest rates.

The rate at which U.S. businesses are creating new jobs, is slowing. Whereas roughly 225,000 jobs a month were added in 2018, over the past three months the average has been about 170,000 jobs. This decrease is to be expected. After all, the pond from which businesses have been fishing, has become increasingly empty, given the current unemployment rate of 3.6 percent. For quite some time, the number of open job vacancies has been exceeding the number of unemployed.

The earlier mentioned wage increases also have a downside: to the extent that employees become more expensive, the rate at which businesses hire tends to slow.

As a consequence, it wouldn’t surprise me if the number of newly added jobs, on average, will slow down in the months to come. When that average falls below 125,000 jobs – and this might happen rather sooner than later – it would not be enough to push down unemployment even further.

The unemployment rate would then reach its bottom, if it hasn’t reached its bottom yet at 3.6 percent unemployment in April. And this is an important figure. Historically, a recession follows – on average – 12 months after unemployment bottoms out. Partially due to unemployment being close or at a bottom, I would expect economic growth to substantially slow in 2020 and I am increasingly taking into account the possibility of a recession in that year in the U.S.

From the point of view of the Fed, a slowdown in growth – or as the case may be, a recession – would be quite unfortunate. Generally, the impact of looser monetary policy is initially felt in economic growth figures. The impact on inflation becomes apparent only at a later stage. While dependent upon various other factors, 2020 could become the year in which the economy cools, while inflation might get under upward pressure. If this were to happen, a type of “stagflation-‘light’ scenario,” the Fed would have to decide between putting into action its interest rate weapon for the good of economic growth (which would require lower rates) or for the good of price stability (which would require higher rates). And all this in a year of presidential elections, against the backdrop of an incumbent president who is already fiercely attacking the Fed.

Whereas this might cause some uncertainty regarding Fed policy among investors, I am quite convinced that the central bank will decide in favor of growth over price stability (assuming that inflation does not exceed the Fed’s inflation target by too much, in which case I expect the Fed to downplay inflation by pointing at temporary, one-off factors and a slowdown which, with some lag, will lead to lower inflation down the line). In other words: it would not surprise me if 2020 becomes the year of low growth and a lowering of interest rates by the Fed. Against the backdrop of such a scenario, we should expect higher rather than lower gold prices at the end of 2020.

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