Jobs Market and Inflation Come in Hot: But There’s More to the Story

After responding to major news on jobs and inflation, as well as reacting to the increasingly deadlocked Russian-Ukraine war, the S&P 500 Index closed the week almost precisely where it began. Other developments that contributed to market movements came in the form of readings on the housing market and consumer confidence.

Friday’s March employment report shows more people returning to the workforce. The month caps off the first quarter, which saw more than 2.115 million workers coming back into the labor market, with the rate of return increasing since September’s end of pandemic unemployment benefits. To paraphrase Mark Twain, reports of permanent job abandonments due to a Great Resignation were greatly exaggerated.

With that backdrop, let’s dive into some of the data we’ve been watching over the past week.

Wall Street wrap

Employment gains: Employment data for March shows the economy gaining 431,000 jobs, plus another 95,000 jobs added to the total due to upward revisions for January and February. The unemployment rate now stands at 3.6 percent, down from 3.8 percent, even as more than 418,000 people re-entered the labor force for a total of 2.115 million in the first quarter – the third highest three-month tally in the data’s 75-year history. The economic recovery needs this trend to continue. According to the Bureau of Labor Statistics’ most recent thorough look at job openings and labor turnover — its JOLTS report for February — there are 11.2 million job openings but only 6 million unemployed workers as of the March report to fill them. To be sure, rising productivity to some degree eases the pressure for more labor, but growth will continue to require attracting more workers. That, fortunately, seems to be occurring as the pace of return has accelerated markedly since extended unemployment benefits ended in September. We believe there are still more workers on the sidelines, but this is a number we’ll be watching closely in the coming months.

Inflation stays hot: The wild card is inflation and the Federal Reserve’s attempts to rein it in. Last week we learned that prices as measured by the Fed’s preferred inflation indicator, the Personal Consumption Expenditures (PCE) Index, rose 6.4 percent in the year through February, up from the 6.1 percent increase in the year through January and the fastest inflation rate since 1982. The pace of increases has picked up and may continue to rise in the short term if sanctions on Russia continue to affect energy prices. However, inflation will likely begin to even off in coming months as year-over-year comparisons start to reflect the upswing in prices that began in the spring of 2021. Another force moderating inflation is the spending shift underway from goods to services. During the pandemic, spending shifted from services to goods, causing supply chain backlogs. That’s now returning to normal, as last week’s personal income and spending report showed that spending on goods declined 2.1 percent in real terms, while spending on services rose 0.6 percent. This trend should continue.

The Fed is now embarking on a process that will require delicate balance: reining in inflation without throwing the economy into recession. We’re likely to see more volatility in the coming months as investors grapple with questions over whether the Fed will err on the side of fighting inflation or recession avoidance. Odds favor the latter since when push comes to shove, the Fed would rather live with slightly higher inflation amid fuller employment.

ISM data may help: As we have been noting for some time, pandemic-related inflation continues to slow, which should make the Fed’s job easier. Last week’s release of the ISM manufacturing index for March, a snapshot of the goods-making sector, showed new orders falling to the lowest level since May 2020, a sign of potential future slowing. In addition, backlogs of old orders fell, and customer inventory levels rose. While it may seem counterintuitive, falling orders are actually a good thing, as it points to the potential for falling future prices on the goods side, even as the recovering services sector and rising energy and food costs fuel inflation. In fact, rising fuel costs ricocheting through the economy are likely to dampen demand on their own – again putting downward pressure on the inflation picture.

Mixed consumer confidence: The Conference Board’s broad Consumer Confidence Index increased slightly in March, to 107.2, up from 105.7 in February. While the group’s index, based on consumers’ assessment of current business and labor market conditions, improved to 153.0 from 143.0 last month, its index based on consumers’ short-term outlook for income, business and labor market conditions declined to 76.6 from 80.8. Almost a quarter of consumers surveyed, 23.8 percent, expect business conditions to worsen over the short term, up from 19.9 percent last month.

A word about yield curves: Finally, there is the nuanced story being told by yield curves. Some are inverting, some are near to inverting, and some aren’t showing signs of inversion at all. There are important points to keep in mind about yield curve inversions amid all the headline noise. Yes, yield curve inversions do often signal an upcoming recession, but not always. On several occasions in the past, the yield curve inverted, and the economy kept growing. Even when the curve inverted and a recession ensued, the lag between the events varied from several months to as much as nearly three years. In terms of market impact, previous inversions often have been followed by market gains that continue until a recession begins — and sometimes even then the gains don’t fall below the level at the time of the inversion. Also,  significant Treasury bond purchases by the Fed and other central banks over the past few years likely have distorted the yield curve, probably making it a less useful predictive tool than in the past. 

For investors, the mixed signals being sent by yield curves means that a recession isn’t out of the question. But we remain steadfast in our view that the Fed’s overarching goal is not to tighten the U.S. economy into a recession through interest-rate hikes but rather to fine-tune policy so the economy can keep moving forward and draw more Americans back into the labor market. Given that perspective on the Fed, consumers  whose debt-to-income levels are at historic lows and the current strength and direction of the economy, if a downturn does come, it is likely to be mild and more apt to begin in two or three years, not the immediate future. Now is the time for prudence, not retreat. 

The week ahead

The first full week of April has a light calendar of significant data releases. If the growing stalemate in the Russian-Ukraine war leads to some indication that Russia is willing to negotiate an acceptable resolution, markets could rally on the chances for peace. Here’s what to anticipate over coming days:

• Monday: The focus at the start of the week will be on the manufacturing sector as the Census Bureau reports on factory orders and core capital equipment orders for February. The data are expected to show slight declines.
• Tuesday: The service sector of the economy receives attention next, when the S&P Global Markit services PMI and ISM services index numbers are released. Expectations are they will be unchanged or slightly higher.
• Thursday: The weekly employment and jobless claims numbers are expected to show continuing strength.
• Friday: Revised numbers for wholesale inventories in February could indicate a buildup, signaling a possible slowing in consumer demand.

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