Mixed messages behind the headlines of a blowout US jobs report

A blowout US jobs report on Friday has intensified debate about whether the Federal Reserve will raise interest rates again this year, with economists and analysts divided over the strength of the data and how far it will influence the direction of monetary policy.

Employers added 336,000 new roles in September, figures from the Bureau of Labor Statistics showed. That was sharply higher than an upwardly revised figure of 227,000 for August, and well above consensus estimates of 170,000. 

Behind that striking headline number, however, were more mixed and complex messages about what the report meant for the economy, interest rates, the bond market and equities.

‘Strength without heat’

The overall picture suggested that the “economy is still continuing to grow and run pretty well, despite higher interest rates and tighter financial conditions”, said Wylie Tollette, chief investment officer of Franklin Templeton Investment Solutions, who saw that scenario increasing the odds of the Fed raising borrowing costs once more in 2023.

Friday’s report also showed that the US unemployment rate had held steady at 3.8 per cent, while average hourly wage growth — a number closely monitored for signs of accelerating inflation — slipped from 4.3 per cent to 4.2 per cent annually.

“Clearly wage growth is moderating — and that, to me, is the single most important metric,” said Kristina Hooper, chief global markets strategist at Invesco.

Further complicating the narrative, the job gains announced on Friday were driven narrowly by industries that had lagged a broader recovery in the labour market after the initial Covid-19 crisis — such as education, health and leisure, and hospitality.

Strategists said the data suggested that — despite some high-profile wins for US labour unions — many people who had held out for higher-wage jobs were feeling pressure to accept positions with lower pay, amid tightening credit conditions.

The report “says something about a lack of bargaining power on the part of American workers”, said David Kelly, chief global strategist at JPMorgan, who observed that the mixed composition of Friday’s data pointed to “strength without heat”.

The jobs figures will only sharpen scrutiny of next week’s inflation data, with economists expecting an annual consumer price index reading for September of 3.6 per cent — down slightly from 3.7 per cent in August.

If robust jobs growth translates into rising inflation, the Fed might need to turn the policy screws once more, analysts said — with knock-on implications for government bonds and broader financial markets. 

The Fed’s next steps

Beyond inflation, there is perhaps no other data point the Fed watches as closely as the monthly payrolls report. What officials have been looking for are signs of cooling demand across the labour market, which has shown surprising resilience despite a historically aggressive series of interest rate increases.

Before September, the pace of monthly payrolls growth had steadily decelerated alongside the number of job openings, even as the unemployment rate bounced around close to its multi-decade low.

Wage growth has also moderated, providing relief to policymakers who had worried that a tight labour market was fuelling inflationary pressures. Taken together, Fed officials said this amounted to clear signs that the slowdown they have wanted to see is transpiring.

The latest report throws a small wrench into that narrative, but economists by and large conclude that the direction of travel for the labour market towards slower growth has not fundamentally changed.

Given that wage growth moderated again in September and that some seasonal quirks affected last month’s data, many still believe that the Fed will hold off on delivering the final quarter-point interest rate increase that officials last month projected would be needed this year. 

Futures markets on Friday were pricing in a roughly 40 per cent chance of a further interest rate rise this year, up from roughly 30 per cent a day earlier, according to the CME’s FedWatch tool. 

Much will depend on the October 12 CPI report. If that indicates a faster-than-expected inflation pace, Nancy Vanden Houten, the lead US economist at Oxford Economics, believes it “could be enough to cause the Fed to act” at its next meeting beginning October 31.

Bond market repercussions

The jobs report reignited a sell-off in government bonds that had been gathering steam since the Fed’s September 20 policy meeting. At the time, officials held interest rates steady in a range of 5.25 per cent to 5.5 per cent — but their “dot plot” projections pointed to one more increase in 2023 and a slower pace of cuts over the next two years than markets had been pricing in.

Immediately after the report, long-dated Treasury yields shot to fresh 16-year highs, while both the policy-sensitive two-year yield and the benchmark 10-year yield also soared as the prices of the debt instruments sank.

But those yields later slipped from the day’s highs, with some suggesting that investors had returned to the numbers after a visceral reaction and recognised the softer-than-anticipated wage growth figure.

“Since the dot plot, markets have been walking on eggshells,” said Invesco’s Hooper. “There is this heightened sensitivity focused on [rates staying] ‘higher for longer’ that just expands to a general sense that the Fed is going to be more hawkish than anticipated.”

That might ultimately spark a self-fulfilling prophecy, analysts said, with markets working on the Fed’s behalf by pushing up borrowing costs.

In the corporate debt world, risky borrowers have already felt the pressure of rising rates and worries about “higher for longer” funding costs, with the spread between yields on junk bonds and their Treasury equivalents widening from 4 percentage points in late September to 4.33 percentage points by the end of Friday.

But JPMorgan’s Kelly predicted that long-term interest rates would come down over the next year because “inflationary pressures do not look extreme”. That should help stocks and bonds, he added, but “the big picture is that the economy is going to be slowing”.

In markets, “the fever may rise a little bit more — but my guess is that this time next year, we’ll be worried more about the chills rather than fevers”.

Equity investors find reasons for optimism

Wall Street’s benchmark S&P 500 and the technology-heavy Nasdaq Composite initially dropped following the hot jobs data. But those declines soon reversed, with both stock indices closing up more than 1 per cent on the day.

“The reaction is pretty surprising,” said Tim Murray, multi-asset strategist at T Rowe Price. “You would think a very high number like we had would have spooked investors even further about inflation, about the Fed.”

Tech, media and chipmaking stocks including Facebook-owner Meta and Disney were among the day’s biggest gainers. The rally helped US shares to a small weekly gain, after closing out their worst month of 2023 on worries about “higher for longer” interest rates.

Dean Maki, chief economist at Point72 Asset Management, highlighted the “offsetting forces” within the jobs report. 

“The strength of the report does make it more likely the Fed will tighten, and it did push Treasury yields higher,” he noted, “and those are negative factors for equities.” 

But the numbers also underscored US economic resilience, he said — which could spark optimism about future corporate revenue and profit growth.