A Surprisingly Strong Jobs Report May Complicate the Fed’s Plan on Rates

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities finished mostly flat for the week as a stronger-than-expected jobs report led to strong gains on Friday. The rise offset a weak start to the month sparked by geopolitical tensions in the Middle East and concerns about the economic impact of a now-settled strike at East and Gulf coast ports.

The Bureau of Labor Statistics (BLS) Nonfarm payroll report showed that 254,000 new positions were added in September—up sharply from August’s upwardly revised total of 159,000 and well above Wall Street estimates. The pace of gains also eclipsed the 12-month average of 203,000 new positions added. Details of the report were also encouraging with the majority of gains (223,000) coming from the private sector, although the hiring underscored the uneven nature of economic growth this year. Employment in leisure and hospitality rose by 78,000 while jobs in manufacturing declined by 7,000. The diffusion index, which is a measure of the portion of the 250 industries covered by the report that added jobs versus those in which employment is unchanged or declining, rose to 57.6 percent, which pulled the three-month diffusion index up to 54.4 from its “near previous recessionary levels” of 51.6 and 50.0.

The BLS’s other jobs report, the Household survey, also showed strength as the unemployment rate declined to 4.1 percent in September, down 0.1 percent from August’s reading. The latest report shows that wages for production and nonsupervisory employees grew by 0.3 percent in September and are now up 3.9 percent year over year, still above the 3.5 percent pace the Fed views as consistent with inflation running sustainably at a 2 percent annual pace.

The surprising strength of the employment data marked a departure from a series of reports that had pointed to a cooling jobs market. Indeed, June and July’s reports showed monthly private sector gains of less than 100,000, while August’s revised number was still below the 12-month average for monthly gains. Whether last week’s report is an anomaly or a signal of stabilization of employment may take a few months to determine. In the meantime, it could serve to bring the price stability side of the Fed’s dual mandate—maximum employment and price stability—back into focus.

Recall that Federal Reserve Chair Jerome Powell noted at the Fed’s Jackson Hole, Wyoming, symposium in August that, “We will do everything we can to support a strong labor market as we make further progress toward price stability.” However, the latest jobs data taken along with upward revisions to gross domestic income and disposable income in the final estimates of second-quarter gross domestic product may have the Fed questioning how aggressive it wants to be in cutting rates in the near term. Instead, the Fed may once again turn to signs that pockets of sticky inflation remain and should not be ignored. Simply put, if the job market is stronger than the Fed concluded at its September meeting when it cut rates by 50 basis points, it doesn’t want to replay the events of late 2023 when it signaled optimism that inflation was in the rearview mirror. Investors embraced that narrative at the time and priced in six rate cuts for 2024, which caused markets to surge and financial conditions to ease as consumers became optimistic. We believe this dynamic likely contributed to inflation during the first few months of this year—a situation the Fed does not want to happen again.

While last week’s jobs report was heralded by many as another sign that the economy is strong and the Fed is likely to achieve its long-sought-after soft landing, we believe it is too early to begin the celebration. Although the BLS data is an important step, other indicators of job market strength are far less bullish. For example, the latest Purchasing Managers Index (PMI) reports from the Institute for Supply Management (ISM) show that hiring in both manufacturing and services is at contractionary levels. Historically, prior to the arrival of COVID, contractionary readings on both sides of the economy in this PMI data would have coincided with a much weaker jobs report than we saw last week. Additionally, the trend for inflation has been promising, but pockets of price pressures remain and the pace of wage growth is still elevated. Recent weeks have seen large employers, ranging from Amazon to Walmart, announcing significant raises for employees. Add to that list the 61.5 percent wage increase over six years that the International Longshoremen’s Association won as a result of its short-lived strike and it is clear workers are still trying to regain the purchasing power of their paychecks that they lost when inflation was at its peak. As a result, we believe wage pressures are unlikely to ease meaningfully anytime soon. Unfortunately, sticky inflation and persistent wage pressures can feed into the type of wage–price spiral the Fed has sought to avoid. As such, the two inflation readings that will be out before the next Federal Open Markets Committee meeting in November will take on even greater significance, as will the October jobs report.

Until then, we continue to believe that investors would benefit by balancing current risks against potential upside performance.

Wall Street wrap

While the jobs report and geopolitical tensions in the Middle East caught most of investors’ attention, other reports out last week suggest challenges remain in the jobs market and that the health of the economy is uneven.

A different view of jobs market strength: Announced job cuts in September totaled 72,821, up 53 percent from the same month a year ago, according to the latest report from Challenger, Gray & Christmas Outplacement Services. The year-over-year jump in cuts comes as the number of announced new hires year to date is now at the lowest level since 2011 as recorded by the outplacement firm since the report’s inception in 2005. The latest data shows 483,490 new positions announced year to date through September, with 401,850 attributed to seasonal employment. The year-to-date total is down 33 percent from the same period a year ago and at the lowest amount since 2011 when the economy was emerging from the Great Financial Crisis. Andrew Challenger, senior vice president of Challenger, Gray & Christmas, Inc., noted in comments released with the report, “Layoff announcements have risen over last year, and job openings are flat. Seasonal employers seem optimistic about the holiday shopping season. That said, many of those who found themselves laid off this year from high-wage, high-skill roles will not likely fill seasonal positions.”

Manufacturing weakness continues: The latest headline reading from the ISM shows manufacturing activity remains weak with September’s measure at 47.2, unchanged from August (readings below 50 indicate contraction for the sector). The latest level marks the sixth consecutive month of contractionary readings and the 22nd time in the past 23 months that the reading has been below 50. Readings for new orders remain weak at 46.1, up 1.5 points from August but still in contraction. Order backlogs also remain in contractionary territory at 44.1 compared to 43.6 for the prior month.

The employment index deteriorated, falling to 43.9 percent, down 2.1 points from August. The July, August and September readings are now among the five lowest readings for the measure since July 2020. Weak demand for employees was widespread, with 11 of 18 industries reporting a decrease in employment and only two industries recording an increase.

The report did offer a potential bright spot as the prices index, which measures input costs for manufacturers, eased to 48.3, a 5.7-point decline from August’s measure of 54. The September reading marks the first time in nine months that manufacturers saw a decrease in costs and only the third time in the past 16 months. Of the six largest manufacturing industries, just two reported price increases.

Services sector strengthens: The latest headline reading from the ISM shows activity in the services sector inched higher in September with a reading of 54.9, up 3.4 points from August’s reading of 51.5 percent. New orders surged to 59.4 from the previous month’s level of 53. Despite strong growth, demand for workers edged lower into contractionary territory, with the employment index coming in at 48.1 compared to August’s reading of 50.2. It’s worth noting that seven of the past 10 employment readings have been in contraction.

Prices paid by companies increased for the 88th consecutive month. The prices index came in at 59.4 percent, an increase of 2.5 percentage points from the prior month. In total, 12 industries reported higher costs, while no industries reported lower costs.

While the report pointed to strength for the services side of the economy, costs and employment are potential sources of concern. In a statement issued with the report, Steve Miller, chair of the ISM Services Business Survey Committee, noted, “Pricing of supplies remains an issue with supply chains continuing to stabilize; one respondent voiced concern over potential port labor issues. The interest-rate cut was welcomed; however, labor costs and availability continue to be a concern across most industries.”

The week ahead

Tuesday: The National Federation of Independent Businesses Small Business Optimism Index readings for September will be out prior to the opening bell. Last month showed a decline in optimism and indicated that price pressures and the state of the labor market continue to weigh on small businesses with many firms raising wages and, most recently, prices. We will watch for signs that point to these trends continuing.

Wednesday: The day offers a look at the minutes from the most recent meeting of the Federal Reserve Board. We’ll be looking for board members’ thoughts on the employment picture and wages as well as discussion about the potential pace of rate cuts going forward.

Thursday: The Consumer Price Index report from the BLS will be the big report for the week. Recent data has shown the disinflationary process has restarted, and we will be dissecting the data to see if it suggests prices continue to ease.

Friday: The latest readings from the BLS on its Producer Price Index will offer a look at changes in costs for buyers of finished goods for September. We will be watching to see if input costs continue to creep higher, which could put pressure on profit margins or slow the pace of disinflation.

The University of Michigan will release its preliminary report on October consumer sentiment and inflation expectations. We will be watching to see how last month’s rate cut by the Federal Reserve has affected consumers’ outlook.

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