January US Employment Situation Report

What happened?
The US Employment Situation Report was released this morning. It showed 517,000 non-farm payrolls added in January1, dramatically exceeding estimates of 189,000. The unemployment rate dropped to 3.4%. However, wage growth met forecasts of 0.3% for the month and 4.4% year over year, which comes on the heels of a relatively tame Employment Cost Index reading showing compensation costs for workers increased 1.0% for the fourth quarter of 2022.
How have markets reacted? What is our take on what is happening?
Stocks reacted negatively, selling off but then rebounding somewhat. This hasn’t shifted rate futures significantly. We don’t believe this will change the Fed’s tightening path, that it is still very likely to hit the “pause button” after one or two more rate hikes. However, it does greatly increase the probability that the Fed will not cut rates later this year since the US economy appears to be in the process of a relatively soft landing.
What is our outlook on the situation?
Our view is that we could be witnessing a relatively painless ‘disinflationary’ scenario underway, one in which inflation continues to moderate with relatively little damage to the job market or broader economy (think soft or softish landing). We believe we are getting closer to an end of tightening by the Fed, that we likely have one or two more 25 basis point rate hikes before the Fed hits the ‘pause button.’ The Fed could even take a page from the Bank of Canada’s playbook and institute a “conditional pause” with tough language around re-instituting hikes if economic data is not satisfactory; that could perhaps be enough to ease the fears of Fed hawks that worry about ending tightening too soon.
What is our resulting investment strategy?
We continue to anticipate volatility in the near term, but also expect an increasing global risk appetite as markets positively re-price recession risks, and ultimately look forward to and discount an economic recovery that could begin to unfold late this year.
What are we watching out for? What are the risks to our view?
There is the possibility that the Fed is not comfortable with the tightness of the labor market, despite continued signs of easing inflation. This would mean the Fed tightens for longer because the labor market is proving to be even tighter than anticipated, weakening the US economy and increasing the risks of recession.
We will want to look for signs of wage re-acceleration, as that is the greatest risk given the tightness of the labor market. We of course also want to follow inflation expectations closely as well, given the Fed believes they are very predictive. A pickup in either one is likely to cause the Fed to err on the side of greater hawkishness.
Footnotes:
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Source: US Employment Situation Report, data as of January 2023, https://www.bls.gov/news.release/empsit.nr0.htm