Reheating a cooling labor market; labor market sends mixed signals ahead of this week’s FOMC meeting

Labor market shows signs of weakness

Early last week, labor market data reinforced the narrative that the economy was on track for a soft landing. The first sign of weakness was illustrated on Tuesday with the release of October job openings falling to 8.70 million, coming in below expectations of 9.30 million, marking its lowest level since March 2021. In response, the 10-year Treasury yield, which had already been trending lower from recent cooler inflation numbers, fell to its lowest point since September to 4.171%. The market read the release with excitement, with anticipation that this could be a clear sign for the Fed to pull the plug on any further rate hikes.

On Wednesday, the November ADP report showed the slowing of private-sector job creation, with companies adding 103,000 workers for the month, missing expectations of 128,000. Notably, what drove much of the reading down was a loss of seven thousand jobs in leisure and hospitality. This marks a shift in the labor market narrative after this sector led job creation during post-pandemic recovery. With this job boost now in the past, moderation in hiring and wage growth can be expected in the new year.

These early-week data readings encouraged market optimism about the outlook of the Fed’s interest rate policy, with hopes that these signs of slowing would sway the Fed to stop raising rates for good.

Labor market shows signs of strength

Friday’s November U.S. employment report complicated the Fed’s outlook. Data came in better than expected, showing signs of strength throughout the labor market. Nonfarm payrolls rose to 199,000, beating expectations of 185,000. Leading the gains were jobs in health care, government, and manufacturing. The return of striking workers from the auto industry and Hollywood also boosted the headline number. Unemployment tightened to 3.70% in November, marking a four-month low, as the labor force participation rate inched higher. Although job openings in October showed signs of slowing earlier in the week, the falling unemployment rate and added jobs in November demonstrate that though cooling, the labor market may not be cooling as quickly as it seemed.

Arguably, most notable in the report was the sharp 0.40% rise in average hourly earnings, which marked the largest gain in four months. When trying to bring down inflation, getting wage growth to a sustainable level is essential for the Fed. While inflation is cooling, the Fed cannot celebrate a victory until wages are growing at a rate consistent with its 2.00% target inflation.

The strong labor market data complicates the outlook of the Fed’s interest rate policy, especially since there was an expectation for payrolls and labor demand to slow. What looked like an approaching end to high interest rates at the beginning of the week in the market’s eyes, was short-lived with hotter-than-expected data at the end of the week. While the expectation for next week’s meeting is still to hold rates, the longer-term projection remains uncertain. The jobs data release leaves the Fed in a “wait and see” mode. Before Friday’s report, according to the CME FedWatch Tool, the market was expecting a 58.00% chance that the Fed would cut rates at March’s meeting. As of Monday morning, ahead of this week’s FOMC meeting, market expectations are at 38.40% for a cut in March.

Considerations for corporations

Over the past few weeks, the market has been more optimistic than the Fed about the path of future interest rates. Swap rates and caps have been lower, creating favorable hedging opportunities for corporations. With an update to the Fed’s economic projections in the coming week, now is the time to watch if this deviation between the Fed and the market will hold true.

The week ahead

This week will be one to watch with CPI data released on Tuesday, PPI data and the Fed’s interest rate decision on Wednesday, and U.S. retail sales numbers on Thursday. While the market is confident in a hold for this week’s meeting, markets will pay most attention to the Fed’s release of its quarterly economic projections to glean a sense of the state of the economy and the Fed’s interest rate policy in the coming year.