Second guessing the second-round effects

Key points

• We think the disappointing payroll data last week won’t prevent the Fed from tapering in November
• We look into second-round effects on inflation from the current spike

We think the bar for the Fed NOT to announce a taper in November is high and has not been reached despite the disappointing payroll report for September. True, the US economy may not have added many jobs last month, but for a central bank still paying attention to the Phillips curve the faster-than expected decline in the unemployment rate combined with another acceleration in wages can hardly be ignored. Moreover, the “stop-gap” solution found in Congress on the debt ceiling, pushing the deadline to December, changes the Fed’s tactical position: announcing a taper in November could incentivize lawmakers to finally “do the right thing” and provide full-year visibility on the matter, after having been made aware that counting on the Fed’s magic money tree may be risky. Finally, outside the labour market the data flow has been more than decent lately.

The recent further drift in market-based expected inflation may also influence the Fed’s decisions in November. Naturally, the accumulation and prolongation of exogenous price shocks – with the further rise in international gas prices drawing more attention – raise the question of “second round effects” which would turn the current spike into a problematic self-sustained upward spiral. While everywhere in the advanced world, the accumulation of excess savings may dampen the usual self-stabilization mechanisms which normally stop supply-driven price hikes from lasting too long, we continue to see more reasons for concern in the US than in Europe. There is no “consumption gap” left in the US – personal spending has come back to its trend level – while it remains deeply negative in the Euro area, suggesting that still comparatively weak demand is chasing the disrupted supply here. Probably more importantly, in the Euro area the current significant rise in hiring difficulties has merely brought them back to where they had been in the three to four years before the pandemic, without at the time triggering any significant acceleration in wages. In the US, conversely, unfilled vacancies have now hit their 20-year peak and are standing significantly above their 2019 level. Moreover, we find comfort in the fact that in Germany, where tensions on the labour market are the highest in the Euro area, the union movement is not seizing the opportunity to force a hard bargain.

We want to take a nuanced view, however. In the US, we think that the conditions for a wage/price spiral are dependent on the continuation of a rapid recovery in demand, which is less and less likely given Biden’s difficulties passing the next steps of the fiscal stimulus. Symmetrically, in the Euro area hiring difficulties have become entrenched in some sectors for which attracting workers is increasingly problematic, which may call for some re-scaling of pay, but probably more as a gradual process than as a “sudden burst” in 2022.