Expert Commentary

Sign of the V Turning to a Deflation W

Jobs data hinting at another downturn.

Back in April last year, after financial markets stabilized, attention turned to what kind of economic recovery might take place. Some said a V-shaped recovery, others a W and others an L. Some overthinkers even touted a square root sign recovery (√) – a partial recovery, down a lot, then very strong. It turned out to be a K.

The K-shaped recovery has happened in the real economy, with the “haves” benefitting from higher asset prices but the “have-nots” suffering with layoffs. Where there has been a V-shape is in many stock markets, of course, but also in employment which has recovered sharply in the U.S. at least.

However, yesterday’s jobs data showed that the recovery in employment could be reversing, with Initial Jobless Claims coming in much higher than expected. As the chart below shows, that means the 4-week moving average of unemployment claims is on a rising trend from late-November. Not only that, Continued Claims data is showing that unemployment is becoming ingrained. That could be a hint of a structural change in the economy.

Why is this important? Well, one of the reasons the U.S. economy has been so successful over the decades is due to its flexible labor force. Quick and efficient calls of “you’re hired,” or, as what goes around sometimes comes around,, “you’re fired” has made the U.S. employment numbers a good barometer of economic health. Whereas in Europe and elsewhere, employees have been furloughed during the pandemic, the U.S. has fired and re-hired, giving a clearer picture of the underlying economy. That is why these unemployment numbers should be a concern. Unemployment appears to be rising again which is significant, especially as the U.S. is not in any widespread lockdown scenario such as the case in Europe. It is a sign that underlying business confidence and conditions are weak.

Consumer price inflation expectations are elevated at this juncture, but history suggests that it is rare to have consumer price inflation without wage inflation, and if employment is weak, wages will remain stagnant. Sure, commodity prices might have established a significant low last April and might continue to rise. In that case, we might have rising consumer prices and rising unemployment, which would result in 1970s style stagflation. That decade was characterized with bouts of asset and debt deflation.

We’re watching employment levels closely in Europe and the U.S. Lower asset prices and rising unemployment will be a clear sign of deflation ahead.

USA Initial Umemployment Claims- JAN 2020