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When Irresistible Forces meet Immovable Objects (ALPSFunds)

In his paper published in 2017 “The Infinity from Nothing paradox and the Immovable Object meets the Irresistible Force1” Nicholas Shackel addressed what happens when two seemingly invincible forces collide. The basic concept of the Infinity from Nothing paradox – which indeed works in the opposite direction, nothing from infinity – puts forth the idea of sudden dramatic change to both forces involved. After the collision it’s infinity or nothing, nothing or infinity, complete change to both. Is this a useful analogy for what’s happening today? We think lessons learned from Newtonian physics apply! 

The Irresistible Force of Federal Reserve rate hikes and Quantitative Tightening is colliding head on with the Immovable Object of today’s job market. 

Infinite Action

The pace and magnitude of monetary policy change undertaken by the Federal Reserve which began in March of 2022 is unprecedented. Never in modern history has a central bank undergone such rapid and large rate increases in such a short period of time, while concurrently reducing the size of the central bank balance sheet. After nearly a decade of consistently easy monetary policy the Federal Reserve is sending a clear message to markets: we are serious about winning the fight against inflation! Federal Reserve policy tends to be an Irresistible Force when applied with such intention.

The impact of higher rates is already visible on interest rate sensitive parts of the economy – higher mortgage rates have dramatically slowed housing activity, and we’re seeing a similar impact on new and used car purchases. However we have not seen much (or indeed any when we look at the data) impact on the single most important driver of economic activity, jobs. Weekly initial claims for unemployment benefits remain at historically low levels, the unemployment rate is now below 3.5%, and employers are unable to fill an unprecedented number of job openings. Today’s job market is starting to feel like an Immovable Object with a structural demand for labor that far exceeds the available supply of workers. 

So far so good – now what?

In one month’s time we will anniversary the start of this tightening cycle. By most measures the Federal Reserve’s actions have been remarkably successful, particularly when looking at the slowing inflation rate. Certain overheated parts of the economy like housing have slowed, yet consumer demand remains strong. While financial markets have been volatile, asset price declines have been orderly and the financial system itself has functioned well. Banks remain solvent, sound and ready to lend money appropriately. 
20230207-chart-1All that is left for the Federal Reserve to declare victory over inflation and return to a neutral policy stance is a cooling labor market. At the current unemployment rate, wage increases will (over time) cause additional inflation, undoing what the Federal Reserve has accomplished to date. Based on everything this Federal Reserve has communicated to markets and their actions in this tightening cycle, they won’t let that happen. Federal Reserve monetary policy is now all about what happens to jobs, and pretty much nothing else. 

Nothing from Infinity

Based on the most recent (extremely strong) monthly non-farm payroll report, this jobs market remains robust! However, there are some indications, both anecdotal and tangible, change could be coming. We’ve had layoffs announced by multiple technology firms, including Microsoft, Meta and Google. The number of unfilled job openings recently declined. Demand for temporary workers is heading lower. Corporate earnings have disappointed. And most importantly the Conference Board’s Leading Economic Index is at levels we’ve seen prior to the last three recessions.   
20230207-chart-2As we’ve written here in the past, declines in employment have always been the final shoe to drop within an economic cycle. When the job market shows signs of cooling, everything changes – nothing from infinity, when Federal Reserve Policy and jobs collide. Job market changes, Federal Reserve Policy changes, and the massive tension built up anticipating the collision is released. 

Lesson Learned

We’ve seen tremendous volatility in stock and bond prices over the past year as markets have digested the impacts of the current Federal Reserve tightening cycle. The current consensus view posits inflation is over, the Federal Reserve will pivot to a more accommodative stance soon, corporate earnings have troughed and the bear market in stocks is over. Two short months ago that consensus was almost the complete opposite – that inflation would remain higher for longer, the Federal Reserve would tighten until something breaks, and corporate earnings could decline significantly. Two wildly different views of the future for sure!

While we certainly know which side we are on, we have done this long enough to rely on the data and adjust as the facts change. Getting too caught up in the emotions associated with big asset price changes can be dangerous, and it’s important to pay attention in times like this to what matters most. And the one thing we are watching to indicate a real change in the path forward is employment. Until we see labor markets change, we think it’s too early to call an end to the Federal Reserve’s tightening cycle and in turn to the current economic cycle. 

Important Disclosures & Definitions

1 Shackel, Nicholas. The Infinity from Nothing paradox and the Immovable Object meets the Irresistible Force. European Journal for Philosophy of Science 8, 417–433 (2018).

Quantitative Tightening: a monetary policy strategy used by central banks where they reduce the pace of reinvestment of proceeds from maturing government bonds in an attempt to raise interest rates, decrease the supply of money, and reduce lending to consumers and businesses.

Conference Board Leading Economic Index: An index of 10 economic indicators including: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; ISM® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500® Index of Stock Prices; Leading Credit Index; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.

Consumer Price Index (CPI): A measure of the average change over time in the prices paid by urban consumers for a representative basket of consumer goods and services. One may not invest directly in an index.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

AAI000175 3/31/2024

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