Navigating Volatility

Macro Markets

This past Friday, according to nonfarm payrolls data, the USA added 517 000 jobs last month and a revision on the December data up to 260 000. The number broke through all estimates by banks, economists etc., as the unemployment rate dropped to 3.4%, the lowest number in 53 years. The gains were across all sectors.

Average hourly earnings ticked up slightly than expected at 4.4%. It is lower and trending down from last month when it was 4.65%.

The labor force participation rate, the share of the population working or looking for work, climbed to 62.4%, and the rate for workers ages 25-54 also increased. Removing the effects of those adjustments, the Labor Department said the overall participation rate was unchanged.

It is possible that this was some seasonal shock. We could also see a revision lower next month. The labor market remains very tight and puts more work on the Fed to ensure this tight labor doesn’t result in higher wage or goods inflation.

The report also contained a yearly update to the establishment survey that produces the payroll figures. Job growth was revised higher for the final six months of 2022

‍Why are payrolls so important?

The market is looking at labor data concerning inflation to see if the economy is healthy and if a soft landing is a real potential. An economy that can provide a high level of employment is typically healthy. During a recession, many people lose their jobs and struggle to find new employment. The unemployment rate rises, which reduces the competition for labor and can drive down wage growth/inflation. Another reason economists follow the jobs report so closely is that it provides insight into the types of jobs people get. This can help them identify economic trends.

For example, this month’s report showed a significant increase in leisure and hospitality payrolls but little change in industries like information and finance. This could indicate that finance and tech firms are at healthy employment levels and are not poised for significant growth.

A much stronger-than-expected jobs report indicates that the Federal Reserve’s job of fighting inflation could be far from over. Though inflation has eased somewhat in recent months, some experts are now predicting more aggressive hikes by the Fed to slow wage inflation and labor growth, which could result in higher goods inflation and disrupt price stability. This is why the markets sold off on the strong job report because the chance of a soft landing dropped, but wage inflation not spiking up gave investors relief that maybe employment grows, but wage growth does not.

Powell & FOMC

On Monday, Atlanta Fed President Raphael Bostic said the labor market's continued strength might compel policymakers to hike further than anticipated. On Tuesday, Powell spoke and didn’t go quite that far but did note that if labor data keeps coming in this aggressively, then there is a lot more for the fed to do and potentially hike more than what's priced in. Powell indicated that "financial conditions have tightened significantly" in response to the latest jobs report. The takeaway is that he's more or less comfortable with current market pricing. The Fed chair did note that the war in Ukraine and China's economic rebound both present some risk of higher-than-expected inflation.

Markets are now pricing in 100% odds that the Fed will hike 25 basis points on March 22^nd at the next fed meeting and 76% odds that the Fed will hike another quarter-point on May 3. That would bring the federal funds rate to a 5%-5.25% range, which December Fed projections indicated would be the likely peak of the cycle. Markets are pricing in about 30% odds that the Fed will have to make one additional rate hike, down from about 40% before Powell spoke. However, markets still see about 75% odds that the Fed will cut its key rate to 4.75%-5% by year's end.

Powell's remarks on Tuesday didn't significantly challenge that outlook. As Powell spoke last Wednesday, the S&P 500 had surged, highlighting that "the disinflationary process has begun." Powell said on Tuesday that the disinflationary process will take time, noting that it has yet to bring down inflation for core services, excluding housing. On a positive note, Powell said that a renewed increase in immigration after a sharp slowdown earlier in the pandemic seems to alleviate the labor shortage.