Strong employment, disappointed Fed?

Stocks were slammed on Friday as investors took a stronger than expected employment number as a sign of doom at the hands of the hawkish Fed. According to the latest unemployment report, the pandemic has come and gone as the unemployment rate hit pre-pandemic lows.

Fear-gripped. It’s no secret that the Fed is on the warpath against high inflation. That is conceptually a good thing, because who doesn’t want to buy things cheaper? The problem however, is that stocks are not on the list of things we would like to see cheaper!! While the Fed’s activity has not yet worked on prices of food, energy, clothes, travel, etc., it has certainly been effective at lowering the prices of the stocks in our portfolios. What’s worse is that the parade of Fed speakers that hit the circuit last Thursday made it clear that the Central Bank would not be influenced by market volatility. Ok, well so much for the now dead-and-buried Fed Put. Those statements combined with all the recent economic data which suggests that not much has changed in either direction put a bit of a pit in the craw of investors leading into Friday’s monthly employment situation.

Low unemployment, according to the most widely accepted economic theory, is one of the causes of inflation. Low unemployment means that companies have to compete to get highly qualified workers; compete means that companies have to pay up. Paying up for workers means that the cost of production rises… and who do you think foots that bill? Why, of course, you and I. Inflation 101. Now it is, as you know, the Fed’s job to assume that Americans have jobs. It is the Fed that has been tasked as the protector of employment. It is also the Fed’s job to ensure that inflation is low. That means that, ultimately, it is the Fed’s job to strike that delicate balance between acceptable unemployment and acceptable inflation. These days that balance is WAY out of whack. Inflation is above 8% while inflation is at record lows. SO, naturally the Fed must sacrifice one, unemployment, to fix the other, inflation. Sorry, folks you can’t have your cake and eat it too in this case – something’s got to give. So if we accept that we have take this tough medicine to heal… so be it. Unemployment is at lows, so we can afford to let that creep up a bit. The market had accepted that reality as of last Thursday night, and the Fed is hard at work pulling levers, pushing buttons, and turning knobs to slow down the tight labor market which will lead to cooler inflation. Proof of the Fed’s progress would come in the monthly employment numbers, like the one that came out last Friday. The problem is that those numbers showed us that the Fed’s already aggressive moves have not hit their mark quite yet. Both the Change in Nonfarm Payrolls number and the Unemployment Rate came in better than expected. In this case, good is bad, if you’ve been following me. The Unemployment Rate came in at 3.5%, exactly where it was just prior to the pandemic lockdowns… A 5+ DECADE LOW. Newly created jobs came in slightly higher than expected but still lower than the prior month. So yes, job creation is still trending in the right direction, down, but the miss was not taken lightly by the stock market.

The market’s initial reaction was a selloff, and as economists dissected the numbers further, the selling increased. The dissection showed that much of the month over month decline came from the public sector and not corporations, as we would hope. While there were declines across the certain sectors, they were minor, and all was overshadowed by a stark increase in the Leisure and Hospitality sectors. That was enough to spook an already on-edge market which ultimately led to Friday’s strong selloff. But was a selloff of that magnitude warranted? To answer that question we need to turn to the bond markets which keep a more direct tab on what the Fed is expected to do. Let’s start with the 2-year Treasury note which attempts to determine where overnight rates might be in 2 years. After Friday’s strong number, the yields on the notes climbed by only +5 basis points, which is a relatively small move considering the stakes. Fed Funds futures did indicate an increase in the probability of a +75 basis-point rate hike next month, specifically from an 88% chance to a 92% chance. Both indicate a high probability of the occurrence and the increase was not material at all. So, according to the fixed income markets, Friday’s number really didn’t change much in the way of interest rate policy, so the selloff was more a reflection of general investor anxiety. This week, we will get inflation data for September and economists are expecting the headline number to tick down slightly. We can certainly expect more volatility around that release… regardless of what the bond markets predict.  Further volatility can also be expected as earnings season creeps in later in the week. Remember, this tough medicine is the prescription for lower inflation.

FRIDAY’S MARKETS

Stocks sold off on Friday after a stronger than expected monthly employment number raised fears of a more aggressive Fed. The S&P500 Index fell by -2.80%, the Dow Jones Industrial Average traded lower by -2.11%, the Nasdaq Composite Index dropped by -3.80%, and the Russell 2000 Index declined by -2.87%. Bonds fell and 10-year Treasury Note yields added +5 basis points to 3.88%. Cryptos fell by -2.34% and Bitcoin declined by -2.49%.

NEXT UP

• No numbers today and the bond markets are closed for indigenous Peoples Day / Columbus Day. Later this week however, we will get Consumer Price Index / CPI, Producer Price Index / PPI, FOMC Meeting Minutes, Retail Sales, and University of Michigan Sentiment. All of them are potential market movers. Earnings season also officially begins later in the week. Please refer to the attached earnings and economic calendars for times and details.
• Today’s Fed speakers include: Evans and Brainard.