Entropy, Inflation, And The Illusion Of Economic Certainty

Good Morning Ladies and Gentlemen

“Particularly that constant changes in entropy are what produce the vitality and vibrancy on which the markets so heavily depend. Both increases and decreases in entropy can be a welcome sign, in order that equilibrium is constantly approached, but never achieved. This should be embraced by investors; they should not run from it.”

Prof. em. Dr Leonard W. ter Haar

What an insightful quote from Prof. em. Dr Leonard W. ter Haar (Leo)! In the upcoming issue of “Stefan’s Weekly”, Leo and I will explore the intriguing question of what insights thermodynamics can provide when analysing financial markets. You will be amazed by the thought-provoking ideas we have prepared for you. I am confident you will enjoy these intellectual and almost philosophical explorations. However, today we will first examine the employment situation in the U.S. and consider how it might influence inflation and interest rates.

The July Job Report

The July employment report has clearly indicated that the U.S. labour market is losing momentum. According to the Bureau of Labour Statistics, the economy unexpectedly shed 23’000 jobs in July, marking the weakest monthly performance in years and highlighting a significant summer hiring slump. While the unemployment rate edged down to 4.1% from 4.2%, this decline was not the result of stronger job creation but rather a drop in labour force participation, as more individuals stopped actively seeking employment. The weakness in the report was further intensified by substantial downward revisions to prior months’ figures. June’s payroll growth was revised down to just 20’000 jobs from an initially reported 57’000, while May’s number was nearly halved, falling from 129’000 to 66’000. Collectively, these revisions suggest that labour market conditions have been deteriorating for several months. The report significantly fell short of economists’ expectations for a gain of 95’000 jobs, raising concerns about the underlying strength of the U.S. economy and increasing pressure on policymakers to take action to support growth.

The Federal Reserve’s Dual Mandate

The evolution of the U.S. labour market is central to the Federal Reserve’s dual mandate of achieving maximum employment and ensuring price stability. A robust labour market, characterised by low unemployment and healthy wage growth, bolsters consumer spending and economic activity. However, it can also create inflationary pressures if labour costs rise faster than productivity. On the other hand, weaker employment conditions tend to restrain wage growth and reduce demand, which can help mitigate inflation over time. This sets up a delicate balancing act for policymakers. If labour market conditions weaken while inflation approaches its target, the Fed may have the opportunity to lower interest rates. Conversely, persistent wage-driven inflation could compel the central bank to maintain a restrictive monetary policy, even in the face of slowing employment growth.

Is The Federal Reserve’s Dual Mandate Unique?

Ladies and Gentlemen, the Federal Reserve stands out among major central banks due to its formal dual mandate, which focuses on achieving both maximum employment and price stability. This prioritisation places the labour market at the forefront of monetary policy decisions, requiring policymakers to carefully balance the risks of inflation with the need to foster economic activity and job creation. In contrast, institutions like the European Central Bank, the Bank of England, the Bank of Japan, and the Swiss National Bank primarily prioritise price stability, with employment considerations playing a secondary or indirect role. Consequently, U.S. payroll figures, unemployment rates, and wage growth tend to exert a particularly significant influence on interest-rate expectations, making labour market data one of the most closely monitored indicators in global financial markets.

Okay, What About Interest Rate Development?

That’s a valid question, I believe. I was already elaborating on it last week and many times before. However, I am still not certain. You know, if we experience a significant super El Niño and the conflict between the U.S., Israel, and Iran ends, inflation forecasts might decline, thus potentially leading to lower interest rates.

Conclusion

I definitely do not consider myself a macro investor. That said, inflation, employment, and GDP growth certainly play a role in my investment landscape, yet it seems to me that making reliable economic forecasts is very difficult and I have little regard for methods like tea-leaf reading or palmistry. I prefer thinking in scenarios and, above all, looking for productive assets, particularly companies that can generate positive cash flows, even in economically challenging times and regardless of the macroeconomic climate. Over my 35 years of experience in the stock market and investment sector, I have consistently observed that many macroeconomic arguments are heavily influenced by ideology. In my opinion, ideology has no place in the investment process, as it tends to cloud any investor’s judgment.

Ladies and Gentlemen

Feel free to send your messages to smk@incrementum.li. Many thanks, indeed!

I wish you an excellent start to the day and weekend!

Yours truly,

Stefan M. Kremeth
CEO & Head of Wealth Management
Incrementum AG – we love managing assets

Tel.: +423 237 26 60
Cell: +41 79 303 48 39
Im alten Riet 153
9494 Schaan/Liechtenstein
Mail: smk@incrementum.li