- Employment is a lagging indicator.
- Nevertheless, the unemployment rate fell to 3.5% last month, suggesting wages still contribute to high inflation.
- The CME FedWatch tool forecasts rates will rise from 3% to 3.25% to 4.25% to 4.5% in December.
Jobs are a lagging indicator because employers are hesitant to lay off people they’ve spent considerable time and money training. The pace of job loss quickens only when internal company business forecasts conclude economic slowing isn’t temporary, and absent cuts, profit – the lifeblood of stock prices – would suffer.
Suppliers are the first target of companies feeling the profit pinch. Once they’ve been wrung dry, attention turns toward other cost-saving moves, such as fewer hours, resulting to some extent in attrition and less hiring. Companies, in the aggregate, send pink slips only when all the levers have been exhausted.
Until that happens, personal spending makes the Federal Reserve's war on inflation tough to win.
Lower unemployment rates don’t yet back “pivot” talk
Friday’s jobs report did little to bolster the argument that the Federal Reserve’s likely to back away from its policy of higher rates.
In September, 263,000 jobs were created nationwide. That was lower than the 315,000 jobs created in August, but according to Real Money’s Stephen Guilfoyle, expectations were for 255,000. The unemployment rate, which the Fed closely watches, actually declined to 3.5% from 3.7% the previous month. Wage growth was also strong, up 5% versus one year ago.
So, if you’re waiting for rising unemployment to force the Fed to change its course, you will have to keep waiting.
In “Breaking Down the Jobs Report,” Action Alerts PLUS co-Portfolio Managers Bob Lang and Chris Versace write:
“Another hot number. This is not going to inspire the Fed to ease up on a hawkish policy. Rather, this report will likely embolden the committee to continue on its campaign to snuff out inflation. In fact, I looked at the Fed funds futures this morning, and going out to March of 2023, it's starting to price in the 5% rate on the Fed funds futures… So we're currently at 3%. We heard from the Fed a couple of weeks ago that they're looking to end the year at 4.4 to 4.5%. So pricing in another 50 basis points on top of that in the early part of 2023…”
Currently, the Fed Funds rate is at 3% to 3.25%, and after the jobs report, the CME’s FedWatch tool shows an 84% probability we move to 3.75 to 4% on November 2. On December 14, there’s a 68% likelihood that rates will reach 4.25% to 4.50%. So, markets expect a fourth consecutive 0.75% increase in rates early next month, followed by another 0.50% before Christmas.
Higher rates take time to work their magic.
Guilfoyle estimates it takes about nine months for the impact of policy decisions to be visible in the economy. Therefore, GDP contraction in Q1 and Q2 could have been more about supply chain disruptions than rate hikes.
This week, the latest Atlanta Fed GDPNow estimate for the third quarter was revised higher to 2.9% growth. There’s time for that forecast to retreat before the official GDP numbers are released later this month, but if it doesn’t, GDP growth provides more cover for the Fed to stay hawkish.
That’s the Fed’s company line, anyway. Based on comments from Fed members this week, they’re clearly in the higher rates for longer camp.
In Friday’s Morning Recon, Guilfoyle writes, “When asked on Bloomberg TV by Mike McKee about the trajectory of forward-looking policy given that futures markets trading in Chicago are pricing in 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 probably won’t change her or anyone else’s opinion on the committee.
Cleveland Fed Nowcast forecast is for September headline and core CPI, excluding volatile energy and food prices, to be 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 it remains stubbornly high. As a result, Nowcast estimates that fourth-quarter core CPI will be 6.55%, up, rather than down, from 6.35% in the third quarter.
It’s a similar situation for the Personal Consumption Expenditures Price Index or PCE. The Fed’s 2% inflation goal targets core PCE, which is headline PCE ex-energy and food. Nowcast pegs core PCE at 5.11% and 5.12% in September and October, respectively. Moreover, it estimates that fourth-quarter core PCE will climb to 5.26% from 4.47% in the third quarter.
Again, that’s not encouraging for those hoping the Fed is near reversing its course.
The Smart Play
Stocks snapped higher on Monday and Tuesday after a dismal September, but most of those gains were erased by the closing bell on Friday. It appears the risk-off trade, selling stocks and bonds to buy money market funds, is still alive.
The fact stocks remain under pressure from higher rates isn’t too surprising, given history shows that stocks perform best when the Fed is cutting interest rates. When it’s hiking rates aggressively (extremely bearish), like this year, stocks falter. The following table from the 1997 edition of Martin Zweig’s Winning on Wall Street reinforces that it's likely to be tough sledding for stocks until the Fed’s friendly again.
Of course, if you’re a long-term investor, that doesn’t necessarily mean that you should change your financial plan. Dollar-cost averaging into the S&P 500 during bear markets has always paid off, because the index has, eventually, marched upward to new highs. Emotional decisions made in bear markets based on short-term data can cause more long-term problems than they fix. Remember, bear markets aren't a new phenomenon.
Short and intermediate-term investors have a tougher row to hoe. The Fed tends to overshoot on cuts and hikes, and although Fed members speak the same tough language now, historically, you can’t take them for their word. Guilfoyle wrote this week, “Remember, the FOMC was going to raise rates through 2019. They cut rates all year that year instead. The FOMC was, at one time, going to stand pat on rates until 2023. Ahem. These kinds of steadfast statements in a period of ongoing uncertainty are both childish and dangerous. They have no clue.”
Given that the first year of bull markets provides significantly better returns than the years that follow, investors will want to keep tabs on the economic data and any potential shifts in the Fed’s language. Until then, it remains important to invest defensively, such as using progressive exposure, avoiding margin, using stop losses, shorting, and limiting exposure to highly-volatile stocks.