As the Labor Market Heats Up, Can Inflation Continue to Cool Down?
The January US jobs report showed a stronger-than-expected labor market with 517,000 new jobs and a 3.4% unemployment rate, raising concerns on Wall Street that this could prompt the Federal Reserve to raise interest rates more aggressively despite moderated wage inflation and increased layoffs, complicating the outlook for inflation cooling and the Fed's monetary policy trajectory.
The January jobs data released on Friday, February 3rd continued to reverberate on Wall Street last week and not in a favorable fashion, as good news for the economy was interpreted as bad news for investors. More specifically, in January, the US added a greater-than-expected 517,000 new jobs and the unemployment rate fell to 3.4%. While we are happy to see more Americans working, Wall Street is growing concerned an accelerating labor market will force the Federal Reserve to raise interest rates higher than hoped for (as of now, the market is “pricing in” a 25bps increase in the Fed Funds Rate at the bank’s March and May meetings).
At the risk of stating the obvious, a strong jobs market should translate into competition for workers, which should translate into wage inflation, which should push broader gauges of inflation higher, which should keep the Fed on a hawkish policy footing. What is interesting is that even as job growth has accelerated, wage inflation has moderated and layoff announcements have spiked. As we have noted before, the labor market is a famously backward-looking economic indicator and we are not yet convinced recent labor market strength will prove sustainable or is proof the Fed is losing its battle with inflation. As it concerns the stock market, last week the S&P 500 fell 1.1%, its worst weekly performance of 2023. What we found more disconcerting was that the BBAgg fell 1.1% and the yield on the US 10 Year Note jumped 20bps to 3.73%.
Our generally optimistic outlook for risk assets is predicated on the real economy slowing if not contracting outright and inflation continuing to come in, allowing the Fed to credibly pause its rate hiking campaign. With its downshift to a 25bps rate hike at its February meeting, the Fed has moved in our hoped-for direction, while the surprisingly robust labor market has made the path forward for monetary policy a bit less certain. And as it concerns those broader gauges of inflation, this week we get a look at the January Consumer Price Index and the January Producer Price Index. Benign readings on both inflation fronts should undo much of the investor anxiety caused by the January jobs data.