Jobs Friday: On the Edge of Our Chair
Fed Reaction Function, Forget Openings, Demand and Churn Point to Rapidly Cooling Wage Growth, Bad is not as Bad for Stocks, at Least Until Earnings Begin
Reaction Function
A month ago, when we wrote our August payroll preview note, we were highly confident the FOMC was going to begin the ‘recalibration’ rate cutting process, but less sure that the Committee’s risk assessment of negative unemployment convexity was similar to ours. The 50bp front loading of rate recalibration, Summary of Economic Projections policy rate forecasts, press conference, and post-meeting FOMC participant appearances suggested the Fed’s mandate weights had shifted to unemployment. At the National Association of Business Economists Conference in Nashville on Monday, Federal Reserve Chair Powell in the Q&A following very brief comments, Chair Powell made three important points. First, the Gross Domestic Income (GDI) upward revisions reduced the risk that Gross Domestic Product (GDP) was overestimating economic activity due to credible research concluding GDI is a better measure of economic activity in real time than GDP. Second, although the revisions to GDI increased their confidence in underlying demand, the labor market has a better track record for detecting economic inflection points than either GDI or GDP. Third, the FOMC was relatively indifferent to the mix of the three components of core inflation he detailed in his November 2022 speech, core goods, housing services, and non-housing services.
Chair Powell also made a subtle inference, repeating a point he made at the press conference two weeks ago, that the labor market is not a source of inflationary pressure. The Chair’s simplified wage cost push inflation model, wage growth less productivity equals inflation, taken with positive comments he made about productivity growth, suggests the Committee is comfortable with 4% wage growth due to an increase in productivity growth from ~1.5% to 2%. Chair Powell also repeated his press conference comments that he adjusts headline employment growth for the birth/death model overestimation (68,000 per month is the linear extrapolation) evident in the first estimate of the annual benchmark revision for the year ended March ‘24.
The consequences of Chair Powell and the FOMC viewing the employment report as the most important economic risk, overestimation of nonfarm payrolls, 4% wage growth is noninflationary, and the rate of change in the unemployment rate is more significant than the level, suggest the most important number Friday morning is the U3 unemployment rate. The evolution of the Fed’s policy reaction function also implies that equities, credit and Treasuries are likely to be less sensitive to weak labor market data than was the case following the last several employment reports. We do not think the equity market is immune to a ‘Fed is behind the curve’ growth scare, but a pullback will likely require additional data like weak retail sales or more likely, 3Q earnings season raising concerns about elevated 4Q24 and ‘25 estimates.
