Jerome Powell and the Case of the Stupendously Strong Jobs Report

Bullishness remained on full display this week – just as it has been for most of 2023. The S&P 500 capped January by rising 6.18% – its best January performance in four years. The momentum carried into February’s early trading with investors cheering corporate cost cuts and stock buybacks. January’s buyback announcements tripled from the year prior, with companies announcing plans to repurchase $132 billion worth of their shares. The announced buybacks were also the highest January totals ever, topping 2021’s previous record by more than 15%. In aggregate, the announcements signal that companies believe their shares are undervalued following 2022’s selloff. On the economic front, the jobs report threw the world of economics on its head with an estimated 517K added to the payrolls in January. This crushed estimates of 187K. The jobs number was surprising to everyone given a backdrop of declining goods and services demand at the end of 2022. Q4’s demand dip appears to have been short-lived, however, as consumers accelerated their services spending in January. If sustainable, this week’s data reflects a utopian condition, where the gravitational forces of supply and demand have been suspended to allow supply to decline, demand to increase, but prices to still moderate. The Fed is likely to be skeptical of such economic fiction but that did not prevent the S&P 500 from delivering another winning week, rising 1.62%. 

Jobs Provide a Jolt

January’s jobs print was simply stunning. Nonfarm payrolls rose 517K, destroying estimates of 187K. The strength of hiring in January pushed the unemployment rate down to 3.40% (from December’s 3.50%), resulting in the lowest jobless level since May 1969. The drop in the unemployment rate comes even as more workers came off the sidelines to rejoin the labor market, pushing the labor force participation rate to 62.40% from 62.30% in December. Jobs gains were broad-based with leisure and hospitality continuing to lead the gains, up 128K for the month. Professional and business services (+82K), government (+74K), and healthcare (+58K) also posted jobs gains. Companies continued to hire and retain workers despite signs of consumer demand having wanted in Q4. With the shift in consumption from goods to services, one would normally expect manufacturers to initiate layoffs, but as the recent ISM Manufacturing survey showed, businesses have been reticent to implement layoffs due to the expectation that business will reaccelerate in 2H 2023. With worker demand still hot, wages posted solid gains. Average hourly earnings rose 0.30% for the month and were up 4.40% from a year ago. While the wage growth was strong, this was down from December’s 4.80% yoy growth. This was an extraordinarily strong jobs report – so strong that it calls into question whether there are some errant seasonality adjustments amplifying the results as some economists have speculated. Be that as it may, until proven otherwise, this report is likely to be of great concern to the Fed.

Fed Pushes Back on Pivot Talk

After January’s monster jobs report, investors should reset any expectations of a Fed pivot anytime soon. To that end, the Fed announced another 25 bps hike on Wednesday following the conclusion of the FOMC meeting. This was the 8^th hike in the current tightening cycle. Wednesday’s hike brings the benchmark lending rate to a range of 4.50% to 4.75%. In post-meeting comments, Fed Chairman Jerome Powell pushed back on the market narrative that rate cuts could be on the table for later this year, reiterating the central bank’s commitment to fighting inflationary pressures. He continued to flag core services, excluding housing, as having been largely immune to disinflation thus far and he shared his concern that service prices could trend higher in the short-term. Powell also said the Fed could raise rates a few more times prior to any pause or reassessment. Powell’s comments fell on deaf ears, however, as the market keyed in on Powell’s acknowledgement that higher rates were definitively having an impact on inflation. Current expectations are that the Fed will pause around the 5.00%-5.25% level, which, with this week’s increase, puts us a mere 50 bps away. 

Services Heat Up as Manufacturing Cools

After December’s cold snap hobbled demand for services, consumers were back to spending again in January. The ISM Services Index rose to 55.2, 6 points higher than December’s 49.2 reading. Numbers above 50 indicate expansion while numbers below indicate contraction. Businesses saw a strong pickup in demand with the gauge for new orders rising to 60.4 in January from 45.2 in December. Prices also continued to ease modestly, dropping to 67.8 from 68.1 in December as supply bottlenecks eased. The strength of January’s print is somewhat noisy, however, given that abnormally cold weather in December crimped demand. This week’s cold snap could have a similar effect to February’s report with the freeze impacting travel across the U.S. Ice or no ice, manufacturing continued to slide as consumers refrained from spending on goods. The ISM Manufacturing Index fell to 47.4 in January, down from 48.4 in December. This was the third straight monthly contraction which pushed the index to its lowest level since May 2020 and below the 48.7 mark viewed as consistent with a recession in the broader economy. In the near-term, business looks to remain slow with the gauge of new orders at 42.5, the lowest reading since May 2020. Even though not much is presently happening on the factory floor, manufacturers remain optimistic business will pick up in 2H 2023.  

Final Thoughts

Julia Pollak, Chief Economist at ZipRecruiter, summed it up best saying, “Today’s jobs report is almost too good to be true. Like $20 bills on the sidewalk and free lunches, falling inflation paired with falling unemployment is the stuff of economics fiction.” This week’s employment report, if it holds up to future revisions, is even more extreme than the quote above would suggest. We had workers reentering the labor market in January. This additional supply was absorbed and then some, resulting in the overall unemployment rate declining. And, it wasn’t just hiring. Wages grew and the average work week expanded, meaning workers are putting more dollars in their pockets. To top it all off, there are presently two job postings for every unemployed individual, giving workers confidence in their financial security. On the one hand, this is an ideal situation if prices continue to moderate, but historically there has been a strong relationship between labor scarcity, job security, wage gains, the propensity to spend and inflation. The question is whether this week’s strong jobs market data or last week’s tepid consumer spending and GDP data paints the more accurate picture of the current economy. In late November and early December there were growing indications that rates were forcing a contraction in growth, but once the market sniffed a potential Fed pivot in the air, intermediate and long term rates fell, mortgage and refinancing spiked and services spending accelerated. The Fed may control the short-end of the yield curve, but the long-end is the sovereignty of the market. Once the market believed inflation was under control, rates fell 1.00%-1.25% (using avg. 30 YR mortgage rates as a proxy for consumer loans) and in doing so rates have descended to a level that consumers now appear comfortable spending again – particularly given their employment prospects.  Whereas the market applauded this week’s data as a sign of a soft landing, the Fed is likely to have received a different message, heeding it as a warning against pivoting too soon.

The Week Ahead

It will be a relatively quiet week for economic news with the trade deficit and consumer sentiment being the highlights of the week.