High Yields, Strong Earnings, and a Fed Waiting on Jobs

**SPEAKER_1** (0:00)
Joining me now, Thierry Wizman, Global Effects Rate Strategist at Macquarie Group. Thierry, great to have you on this Friday. Let's talk about this jobs number, this much stronger than expected number that came across this morning. 162,000 jobs versus the 50 to 55,000 that was expected. Does that reinforce your view that the Fed ultimately needs to hike, or is inflation still the deciding factor here?

**Thierry Wizman** (0:24)
I think inflation still is the deciding factor, but let's not kid ourselves. The Fed does see a relationship between the amount of tightness in the labor market and the amount of inflation that an economy can endure. So when it sees a tight labor market, I think a lot of people on the FOMC will assume that this is a more inflationary environment than it otherwise would be if there wasn't that labor market slackness. Having said that, the proper measure of labor market tightness or slackness from the Fed is the unemployment rate. So whereas this was a very strong report, you know, if you would reference to the non-farm payroll growth and the amount of employment growth in the household survey, I think what could be the deciding factor if this report were a deciding factor is the fact that the unemployment rate is still very low at 4.1%.

**SPEAKER_1** (1:11)
And as we look ahead to next week's CPI and how that comes into the equation, I mean, what has to happen there to really solidify that we are getting a hike in September? I know in your note that you sent over, you said that you believe Kevin Warsh's Jackson-Holz speech essentially greenlit the idea for a hike. Is an inline inflation report enough to keep that green light green, or does it have to be hotter than expected?

**Thierry Wizman** (1:38)
It probably is enough, and I'll tell you why, because if you simply look at recent inflation in the US and you look at the four broad measures that people like to look at, the core CPI, the headline CPI, the core PC price index, the headline PC price index, three of those four are running close to or above 3%.
There's only one of them, which is the core CPI, which is running below 3%, but it's still above 2%, which is the Fed's target. So you don't really need to build a stronger case than we might already have for why the Fed should at least try to defend price stability here and try to restore its credibility with at least another 25 basis point hike. Inflation has been high, it's been high and sticky for just a little too long in the US.

**SPEAKER_1** (2:23)
And as we look at inflation and where oil comes into the equation, I was just talking to Jeff Pierce a little bit about this. And at what point do we stop talking about oil as being a short-term driver of inflation with this ongoing situation with Iran and also Ukraine and Russia, and start talking about it potentially becoming a serious stagflation problem for the global economy and not just a geopolitical risk premium?

**Thierry Wizman** (2:52)
Right. So high oil prices can always translate to higher inflation. But before we even talk about convincing the Fed that oil prices will stay high, we need to convince the market.
If you look at the futures curve for Brent, for WTI, it is in backwardation, which means that prices for oil delivered six months from now, delivered 12 months from now, are much lower than current spot delivery prices. So the market seems to be convinced that this is not going to be a long lasting issue that is of high oil prices. If the market doesn't believe it, it's hard to imagine the Fed will believe it. However, we're not talking just about inflation. We're also talking about inflation expectations, and sometimes those inflation expectations are fashioned or made by where current inflation is. So if oil prices stay high, and it does help maintain high inflation, and that translates into high inflation expectations, the Fed may respond to that, even if the forward curve, the futures curve on oil is still inverted, is still in backwardation. So we need to watch, I think more, if to answer your question, we need to watch CPI itself, we need to watch expectations of CPI as well. I think those two combined are much more important than what oil is actually doing in the spot market.

**SPEAKER_1** (4:12)
And another interesting thing that we've seen with these geopolitical shocks is that normally it would trigger a flight into Treasuries and into the dollar. We've seen something a bit more complicated recently. What is the FX market actually telling us about the current environment?