What happened? 

The US employment report for September contained nothing that alters the macro picture:

• The US economy continues to add jobs at a robust rate (263k in September) …
• The unemployment rate (3.5%) remains well below its long-term sustainable level and …
• Wages are increasing at a steady pace (+5% YoY) that is inconsistent with the Fed’s 2.0% target.

In order for the Fed to conclude that its tightening has had the desired effect of weakening the labor market to bring the economy back into equilibrium, we will need to see tangible evidence that the labor market is weakening—the latest report shows no such evidence. For greater perspective on Chairman Powell’s Plan, please read the latest letter from our Co-Heads of Investment Strategy, Alex Chaloff and Beata Kirr. 

Fed implications

With little new evidence one way or the other, we continue to expect the Fed to tighten aggressively, with either a 50 b.p. or a 75 b.p. hike at its next meeting (we’ve penciled in 0.50%, pending the next inflation print) and additional tightening for several months thereafter. To put it simply, bringing inflation under control is going to cause weakness in the labor market and we haven’t seen that weakness yet. As such, the Fed will continue on its path.

Parsing the data

The economy added 263k jobs in September, comfortably more than the 75k–100k new workers joining the workforce in any given month. From a policy perspective, it won’t be until fewer workers find jobs than enter the labor force that the labor market will truly be weakening. The moving averages of payrolls gains show a modest deceleration over the course of this year, but nothing that would count as weakness. As you would expect, given the strength of hiring, the gains this year have been broad-based, with most major industry groups still adding workers. The exception in September was finance, where weak market performance may be taking a toll on employment.

Strong hiring continues to keep the unemployment rate low; the 3.5% print this month is the cycle low. Month-to-month fluctuations in unemployment are driven as much by the participation rate as by hiring; the household survey (from which the unemployment number is drawn) showed just about the same number of job gains as did the establishment survey, but a 0.1 percentage point decline in the participation rate pushed the unemployment rate lower. We wouldn’t make too much of small moves in the unemployment rate at this point—low is low. What is noteworthy about unemployment is that it is still below the lower bound of the Fed’s forecast range. Remember that the Fed’s forecast represents a “best-case” scenario in which the labor market slows enough to bring inflation under control but not so much as to cause a recession. They need unemployment to go up—if it doesn’t, they are going to have to tighten more than they expect.

The participation rate remains well below pre-pandemic levels and is likely to stay that way. An aging society and changing employment preferences among older workers such that participation among those 55+ has fallen sharply means that overall participation is likely to stay lower than it was a few years ago. The overall participation rate has vacillated between 62% and 62.5% all year even as participation among prime-age workers has recovered almost all of the pandemic-related losses. Barring a dramatic change among older workers, what you see is what you get here: overall participation is likely to move sideways.

With hiring strong and unemployment low, it is not a surprise to see wages remain robust. The Average Hourly Earnings measure of wages is up 5.0% over the past year—a stable rate of growth. Other measures show more acceleration, but all measures agree that the current rate of wage increases is inconsistent with the Fed’s 2.0% target. The good news from a growth perspective is that the strength of the labor market is keeping the aggregate household paycheck in positive territory, even taking into account elevated inflation. That’s an important argument in favor of a mild, rather than a more significant, recession still being possible.

Where to from here

As mentioned above, Friday’s report provided no evidence for the inflation optimists that the economy has weakened sufficiently to bring down cost increases. Those waiting for some evidence of inflation’s peak will have to wait until, at least, the next CPI data print in less than a week (October 13). From an investment perspective, our drumbeat remains the same—volatility should continue until evidence does definitively arrive. And yet, for those with a long-term time horizon for their wealth, investing into (or remaining invested through) uncertainty may well prove beneficial over a multiyear horizon.