The labor market is cooling, inflation remains stubborn, and consumers are losing purchasing power. The Fed has no appetizing choices left.
KEY TAKEAWAYS
The economy added only 29,000 jobs in September, far below the 90,000 economists expected. Revisions also erased 60,000 previously reported jobs from July and August.
The three-month average has fallen to roughly 50,000 new jobs per month. That signals a cooling labor market, although it does not yet indicate an economic collapse.
Hourly wages grew 3% from a year earlier while the Fed projects headline inflation of 3.7%. That means workers’ purchasing power is continuing to shrink.
The Fed faces an uncomfortable choice between persistent inflation and weakening employment. Raising rates risks worsening the slowdown, while cutting could reignite price pressures.
Stocks rallied because the weak report reduced expectations for another rate increase. Investors must now consider when weaker consumers and slower growth will begin affecting corporate earnings.
MY HOT TAKES
The Fed’s September rate hike may have been based on an economy that no longer existed by the time policymakers acted. Monetary policy works with a delay, and revised data makes that delay even more dangerous.
The repeated downward revisions matter more than the disappointing September headline. When the data consistently changes in one direction, confidence in the Fed’s “healthy labor market” narrative should weaken.
A 3% wage increase is not good news when inflation is running at 3.7%. Workers are receiving nominal raises while quietly losing ground in the real world.
Wall Street’s bad-news-is-good-news reflex has limits. A softer economy can support valuations through lower rate expectations, but eventually it threatens revenue and earnings.
Slower wage growth may boost margins for labor-heavy businesses in the short term. The catch is that those same workers are the customers expected to keep spending.
You can quote me: “Margins can look terrific for a quarter or two while the consumer quietly runs out of gas.”
Wavy gravy. In New York, sauce on Sunday is kind of a tradition. To be honest with you, if it were up to me, I would eat pasta every night–I am kind-of addicted to carbs and pasta is the most versatile–up there with bread (which also has magical powers over me). But, alas, my wife, my waistline, and my physician have all decided that once a week is a good compromise. That said, it is a rare Sunday that I miss it. This week is THE big week for my family as we count down the last days before my son’s wedding which means my dietary requirements–despite my insistence–had to take a back seat. So–because I am so flexible (🤣)--I made Saturday night pasta night this week.
I consider myself somewhat of an expert pasta sauce chef. Joking aside, I can whip up pretty much any type from memory and I can give any Brooklyn restaurant a run for its money. One of my secrets is…well, my taste buds. Any decent chef will tell you to taste as you go, but nobody tells you the cruel part. You are always tasting the past. I was reducing my sauce (I don’t call it gravy, though on my block growing up it was a 50/50 split) on Saturday night, and I tasted it, decided it needed salt, and salted it. Twenty minutes later the sauce had cooked down by a third, and my perfectly judged pinch of salt was now a fistful. Nothing about my judgment was wrong. My timing was. The spoonful I tasted wasn't the sauce I served. Monetary policy works exactly like that reduction–it keeps cooking long after the chef has moved on. Just a few weeks back on September 16th, the Fed tasted the economy, said it was strong, and reached for the salt. Last Friday's jobs report suggests the sauce had already been reducing.
So let's taste what actually came out of the pot. Nonfarm Payrolls (the government's monthly count of jobs outside of farms) rose by just 29,000 in September. Economists were looking for 90,000–that's a miss of roughly two-thirds. The unemployment rate ticked up to 4.2% from 4.1%. Not great, but honestly, the headline wasn't what made me put down my very-worn wooden spoon. It was the revisions. August, which was first reported as a very respectable 162,000 jobs, was revised down to 133,000. July–believe it or not–went from a gain to a loss of 10,000 jobs. Add it up and 60,000 jobs we thought we had simply evaporated from the prior two months. Smooth out the last three months and the economy has been adding about 50,000 jobs a month. About 50,000–in an economy of this size–that's a simmer, not a boil. 🍲
Let's get something straight off the bat, because I get the conspiracy emails every time this happens: revisions are not somebody cooking the books. The Bureau of Labor Statistics publishes a first estimate before every employer has sent back its survey, and then it updates the number as the late responses roll in (think of the first print as the spoon-taste and the revision as the sauce after it has reduced). The problem isn't that the numbers change. The problem is that lately they keep changing in the same direction–down, down, and down again. And when the Federal Reserve makes a decision on the spoonful, it owns the sauce.
Which brings me to the irony that I can't stop chewing on. On September 16th, the Fed voted 12-0 to raise its target by a quarter of a percentage point to 4.00%–its first rate hike since 2023 and the first big move of Chairman Kevin Warsh's tenure. At his press conference, Warsh described the labor market as healthy, and that strength is precisely what gave the Fed room to put inflation front and center. Here's the twist. Before he took the chair, Warsh was one of the sharper critics of the Fed leaning on government data that arrives late and gets rewritten later. He was right–he was absolutely right. He just probably didn't expect to be proven right at his own expense. 😉 To be fair to him, the Warsh Fed has been deliberately trying to move away from being chained to any single data release, so do not expect one jobs report to flip the script. But it does take some of the swagger out of "the labor market is strong."
Now, let's talk about the part of the report that actually lands on your kitchen table–the paycheck. Average hourly earnings rose just 5 cents in September, or 0.1%, to $37.81. Compared with a year ago, wages are up 3%, which is the slowest annual pace since 2021. Three percent sounds fine until you remember the Fed's own projection has headline inflation (as measured by the PCE Price Index, the Fed's preferred gauge) running at 3.7% this year. Do the math. A 3% raise in a 3.7% world is a pay cut wearing a necktie…er, a bowtie. Wages have likely trailed inflation for some six months in a row–six months! And it isn't hard to figure out where a chunk of that inflation is coming from. Gasoline is still about 50% above where it was when the conflict with Iran began, and Brent crude was still trading north of $100 a barrel this morning. Businesses staring at energy bills like that–and at rising transportation costs (diesel is 71% higher than it was a year ago)--tend to do one thing first–they stop hiring. My longtime followers know that I often say that labor is the easiest variable cost to adjust for companies–it’s easier to lay off workers than to shutter a factory.
To be clear, it's not all that bad, and I always try to give you both sides of the pot. Part of the reason unemployment rose is that more people came back into the labor force looking for work–that's a healthy sign, not a sick one. The broader U-6 rate (which also counts part-timers who want full-time work and people who've given up looking) actually edged lower. Healthcare still added 17,000 jobs, though that's well below its 12-month average of 33,000, construction added 11,000, and even manufacturing chipped in 9,000. This is not a collapse–it's a cooling. The trouble is that a cooling job market with inflation still stuck above 3% is the one combination that leaves a central bank with no good moves.
Think about where that leaves the Fed. Hike again into 29,000 jobs and shrinking real paychecks? That would be adding more than a pinch of salt to a sauce that's already too salty. Cut rates with the Fed's own inflation forecast at 3.7% and oil back above $100? That's dumping a bucket of water into the pot and calling it a fix. The most likely answer is neither–the Fed holds and waits for the pot to tell it something. The futures market agrees, sort of. According to Fed Funds futures, the odds of an October hike were down to roughly 22% by Friday evening, though other trackers had it lower, so take any single number with a grain of…well, you know. The next two ingredients are the September CPI / Consumer Price Index on October 14th and the Fed meeting later this month on October 27th-28th. One more thing worth noting: this was the last jobs report before the midterm elections, so expect plenty of political seasoning on both sides this week. It’s going to be difficult, but please ignore the noise and watch the data.
And how did Wall Street react to all of this? The way it often does lately–bad news was good news. On Friday the S&P 500 rose 0.73%, the Nasdaq jumped 1.19% and touched an intraday record led by Nvidia, and the Dow added 250 points, all because a weaker job market lowered the odds of another hike. Even so, the Dow and the S&P 500 still finished the week in the red after a rough stretch for global bonds. Here's what I would be asking myself as an investor. If the market is cheering a slowing economy because it means no more rate hikes, at what point does a slowing economy start showing up in earnings? There's an interesting wrinkle here, too. Slower wage growth is actually a tailwind for corporate margins in the near term, especially for labor-heavy businesses like restaurants, retailers, and service companies (when labor costs grow more slowly than prices, more of each sales dollar falls to the bottom line). But those same workers are also the customers. Margins can look terrific for a quarter or two while the consumer quietly runs out of gas. So, as Q3 earnings season gets rolling over the next few weeks, I would spend less time on the earnings-per-share beats and more time on what management says about the consumer–traffic, ticket sizes, trade-downs (for the record–I always do that anyway). Which of your holdings depend on a shopper whose real paycheck is shrinking? How much of the "no more hikes" rally is already baked in? Those are the questions worth asking now, not after the sauce hits the plate.
So what did I do with my oversalted sauce on Saturday night? I didn't add more salt, obviously, and I didn't dump the pot either. I added a ladle of pasta water and a little more crushed San Marzano (DOP only folks, 😉) tomato, turned the flame way down, and waited. Pro tip: no, you can’t just add sugar–please don’t. Then I tasted it again–carefully this time. It came out just fine. My wife said it was one of my best, though she always says that. ♥️ That's really all I'd ask of the Fed right now. No dramatic new recipe, no panic, just a lower flame and a little patience while the pot finishes telling the truth. Taste as you go–just remember you're always tasting the past. Now if you'll excuse me, I have a wedding to get to, and a tailor who took my measurements before pasta night.
FRIDAY’S MARKETS
On Friday, the S&P 500 rose 0.73%, the Dow Jones Industrial Average gained 250 points, or 0.49%, to 51,176, and the Nasdaq Composite climbed 1.19% to 27,190.86 after touching an intraday record. The Nasdaq 100 closed at a record high. Stocks rallied after September payrolls came in well below expectations, which lowered the odds of another Fed rate hike. For the week, the Dow fell more than 1% and the S&P 500 also lost ground, while the Nasdaq was the only major average to finish higher. Bond yields remain elevated.
NEXT UP
ISM Services Index (September) may have slipped to 55.0 from 55.4. Watch the Services Paid Index–expected to have risen to 73.3 from 72.6.
Later this week: Fed Minutes and University of Michigan sentiment along with a few Q3 earnings season early birds. A light data week, but still some nuggets that can make your sauce too salty, so you better check back in and have a taste.