Do Jobs Data Point to Deflationary Recovery?

The four most significant factors in the August report are:

1. Lessening rate of job loss in the nonfarm payroll data (a second derivative positive);
2. Continuing steady decline in full-time jobs (a second derivative negative);
3. Continuing steady decline in employment year over year (a second derivative negative);
4. The large decrease in the civilian labor force since May.

On balance, there is less bad but still not much good in the latest data. Stocks can continue to look forward optimistically for awhile, but second derivative improvement can not be the only good news forever. One can go asymptotically to zero with second derivative improvements. However, until investors give up hope of first derivative good news, there is no reason why stocks should be driven down by employment news. After all, investors can still hang their hats on improving productivity, while waiting for other good news.

Bond investors can cheer hearing the same news. A continuing contraction of employment is consistent with a deflationary environment. So maybe the behavior of both stocks and bonds over the past month is self-consistent. This would be the case if we had a deflationary recovery. This has happened before, in the 1930s.

There are, of course, three other possibilities:

1. The bond market is wrong and inflation will begin.
2. The stock market is wrong and recession will return.
3. Both markets are wrong and both recession and inflation will occur. This could be the mother of all stagflation if it were to occur under the present circumstances.

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