Stunning Employment Report: What It Means for Investors

In this article we review:

• The background behind the surprisingly strong January employment report
• The implications this report could have on recession probabilities
• How it could also potentially impact Federal Reserve interest rate decisions
• Why this good economic news is also good market news

The Bureau of Labor Statistics January employment report crushed expectations with nonfarm payrolls increasing 517,000 for the month and coming in almost three times the consensus estimate of fewer than 200,000. Job gains were widespread across the economy with leisure and hospitality gaining the highest amount (128,000) and 11 out of 12 sectors adding jobs. The unemployment rate fell to 3.4%, its lowest since May 1969, and hourly earnings rose year-over-year by 4.4%, its lowest rate of growth since August of 2021. The labor participation rate ticked up to 62.4%, its highest level since before the pandemic, signifying more workers entering the labor force.  

Given this backdrop, we believe investors should consider the following points:

The report reflects a great month but is still just one month. As strong as this number appears, it is important to note that it represents only one month of data and, as the saying goes, one month does not a trend make. This report will also be subject to revisions in the months ahead, so to some degree at least a grain or two of caution is probably warranted as to how much should be read into it and precisely how much weight it should carry with investors as upcoming jobs reports will now be taking on even more significance during the months ahead.    

That said, the marginal probability of a soft landing is likely increasing. While we believe recession is still a better than even probability, this report does present a stronger case to be made for the prospect of a soft landing (defined as meaningfully lower inflation while maintaining positive economic growth). Should these job gains not be nullified in the months ahead, the debate could quickly shift from that of a severe versus moderate recession to one of a moderate recession versus soft landing, which should prove favorable for market sentiment.

In our judgment, this report throws cold water on the notion the Fed will cut rates in the second half of the year. In our opinion, this most recent employment data does not support a case for the Federal Reserve to cut interest rates later in the year and we believe it likely solidifies two more federal funds rate hikes by the end of May. This would be consistent with our best assessment that the Fed will take the fed funds rate to a lower bound of 5% by midyear and hold tight (pardon the pun) for the remainder of the year.      

We believe this is clearly a case where good news is good news. Given the market’s continuing focus on Fed policy and inflation, the immediate interpretation of the January jobs report seemed to be one of favorable economic news being negative market news. However, in this case, we side with the theory of more jobs, lower unemployment, and a reduced probability of severe recession being ultimately better for the stock and credit markets over the long term, even if that might create some short-term volatility. We are therefore in the "good news is good news" camp, and we maintain our existing year-end 2023 targets of a 5% lower bound on the fed funds rate and S&P 500® price level of 4,400.   

Again, we caution not to place too much emphasis on any single data point or monthly economic report as there remains contradictory signals of the economy’s future health, such as the trend in the Conference Board Leading Economic Index and the deeply inverted slope of the U.S. Treasury bond yield curve, both of which are flashing strong recessionary warnings. Nonetheless, suffice it to say the month of January has at the very least sent a highly unexpected cross current in the direction of an expected recession.   

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