Jobs data likely means higher interest rates

  • Employment is a lagging indicator.
  • Nevertheless, the unemployment rate fell to 3.5% last month, suggesting that wages are still contributing to high inflation.
  • CME tool FedWatch predicts rates will rise from 3% to 3.25% to 4.25% to 4.5% in December.

Jobs are a lagging indicator because employers are reluctant to fire people they have spent a lot of time and money training. The pace of job losses only picks up when the company’s internal business forecasts conclude that the economic slowdown is not temporary and that in the absence of cuts, profits – the lifeblood share price – would suffer.

Suppliers are the first target of companies feeling the pinch of profit. Once they’ve been wrung out, attention turns to other cost-saving measures, such as cutting hours, leading to some degree of attrition and fewer hires. Companies, on the whole, only send pink slips when all the levers have been exhausted.

Until that happens, personal spending is making the Federal Reserve’s war on inflation a tough one to win.

Falling unemployment rates don’t yet support ‘pivot’ discourse

Friday’s jobs report did little to bolster the argument that the Federal Reserve is likely to reverse its policy of higher rates.

In September, 263,000 jobs were created nationally. This is less than the 315,000 jobs created in August, but according to real moneyby Stephen Guilfoyle, expectations were for 255,000. The jobless rate, which the Fed is watching closely, actually decreases at 3.5% against 3.7% the previous month. Wage growth was also strong, up 5% from a year ago.

So if you’re waiting for rising unemployment to force the Fed to change course, you’ll have to keep waiting.

In “Breaking down the jobs report”, MORE Action Alerts Co-portfolio managers Bob Lang and Chris Versace write:

“Another hot number. This will not inspire the Fed to relax its hawkish policy. On the contrary, this report will probably encourage the committee to continue its campaign to stifle inflation. I actually looked at the fed funds futures this morning, and through March 2023 it starts to factor in the 5% rate on the fed funds futures… So we’re currently at 3%. We heard from the Fed a few weeks ago that it was looking to end the year between 4.4% and 4.5%. So pricing an additional 50 basis points on top of that in early 2023…”

Currently, the fed funds rate is 3% to 3.25%, and after the jobs report, the CME’s FedWatch tool shows an 84% chance that we will move to 3.75 to 4% on the 2nd. november. On December 14, there is a 68% probability that rates will reach 4.25% to 4.50%. Thus, the markets expect a fourth consecutive increase of 0.75% in rates at the beginning of next month, followed by another increase of 0.50% before Christmas.

Scrooges, rejoice.

Higher rates take time to work their magic.

Guilfoyle estimates that it takes around nine months for the impact of policy decisions to be visible on the economy. Therefore, the GDP contraction in the first and second quarters could have been more related to supply chain disruptions than rate hikes.

This week, the Atlanta Fed’s latest GDPNow estimate for the third quarter was revised up to 2.9% growth. It’s time for that forecast to pull back before the official GDP numbers are released later this month, but if not, GDP growth offers more cover for the Fed to stay hawkish.

That’s the Fed’s policy, anyway. Based on comments from Fed members this week, they are clearly in the higher rates for a longer camp.

In Friday’s Morning Recon, Guilfoyle writes, “Asked on Bloomberg TV by Mike McKee about the trajectory of forward-looking policy given Chicago-traded futures markets forecast rate cuts later in 2023, [San Francisco Fed President Mary] Daly said: “I don’t see that happening at all.”

Next week’s Consumer Price Index (CPI) inflation report is unlikely to change his view or that of anyone else on the committee.

The Cleveland Fed Nowcast forecast is for September’s headline and core CPI, excluding volatile energy and food prices, at 8.2% and 6.64%, respectively. In August, the readings were 8.3% and 6.3%. Falling gasoline prices have helped headline CPI, but the core is slower to react and remains stubbornly high. As a result, Nowcast estimates fourth quarter core CPI to be 6.55%, up rather than down, from 6.35% in the third quarter.

It’s a similar situation for the Personal Consumption Expenditures or PCE price index. The Fed’s 2% inflation target targets the core PCE, which is the overall PCE excluding energy and food. Nowcast pegs the base PCE at 5.11% and 5.12% in September and October, respectively. Additionally, he estimates that the core PCE in the fourth quarter will climb to 5.26% from 4.47% in the third quarter.

Again, this is not encouraging for those hoping the Fed is about to reverse course.

The smart game

Stocks rose on Monday and Tuesday after a dismal September, but most of those gains were erased by the closing bell on Friday. It looks like risk trading, selling stocks and bonds to buy money market funds, is still going strong.

That equities remain under pressure from higher rates is not too surprising, given that history shows equities perform best when the Fed cuts interest rates. When it comes to aggressive (extremely bearish) rate hikes, like this year, stocks falter. The following chart from the 1997 edition of Martin Zweig’s Winning on Wall Street reinforces that equities are likely to be a tough sled until the Fed is friendly again.

powered indicator.jfif

Of course, if you’re a long-term investor, that doesn’t necessarily mean you have to change your financial plan. Dollar cost averaging in the S&P 500 during bear markets has always paid off as the index eventually hit new highs. Emotional decisions made in bear markets based on short-term data can cause more long-term problems than they solve. Remember that bear markets are not a new phenomenon.

Short and medium-term investors have a harder time fighting. The Fed tends to outrun cuts and hikes, and while Fed members now speak the same harsh language, historically, you can’t take their word for it. Guilfoyle wrote this week, “Remember the FOMC was going to raise rates through 2019. They cut rates all year instead that year. The FOMC was, at one point, going to stick with rates through 2023. Ahem. These kinds of unwavering statements in a time of ongoing uncertainty are both childish and dangerous. They have no idea.

Since the first year of bull markets offers significantly better returns than subsequent years, investors will want to keep an eye on economic data and any potential changes in Fed language. Until then, it remains important to invest defensively, such as using gradual exposure, avoiding margins, using stop losses, selling short and limiting exposure to highly volatile stocks.

Leslie M. Gill