The Fed’s actions after this week’s meeting will largely depend on whether inflation is actually slowing. Investors will get another clue when the January jobs report is released on Friday.
Economists forecast that 185,000 jobs were added last month, down from 223,000 in December and 263,000 in November. A further deceleration in the labor market could please the Fed, as it would show that last year’s rate hikes are successfully sucking some air out of the economy.
The Fed knows it’s in a tough spot. Inflationary pressures are driven in part by wage increases for workers. In an environment where the unemployment rate is at a half-century low of 3.5%, workers have been able to demand big wage increases to keep pace with rising prices for consumer goods and services.
Along those lines, average hourly earnings, a measure of wages and part of the monthly jobs report, are expected to rise 4.3% year-over-year. That was down from 4.6 percent in December and 5.1 percent in November.
That’s still uncomfortably high, but the trend is moving in the right direction.
The problem for the Fed, though, is that it may need to keep raising rates until there is further evidence that the labor market is cooling enough to push inflation lower.
Recession or Soft Landing?
Several other labor market indicators continue to suggest that the U.S. economy is not in serious danger of a recession at this time. Weekly jobless claims fell to a nine-month low of 186,000 last week. Investors will get the latest weekly jobless claims on Thursday.
Still, some expect wage growth to continue to decline, which should take some pressure off the Fed.
“Wage growth has been on a slowing trajectory, and we suspect slower wage growth will become the trend in 2023 as available jobs shrink,” Tony Welch, chief investment officer at wealth manager SignatureFD, said in a note.
“Workers will be reluctant to give up the bargaining power they believe they have gained over the past year,” Putnam global macro strategist Jason Vaillancourt said in a note.
Vaillancourt also noted that many consumers are still flush with the cash they had hoarded early in the pandemic. This may mean that inflation is not going away anytime soon.
While the pace of job growth may be slowing, economists aren’t starting to project monthly job losses the way the U.S. has in previous recessions.
“Combine that with a strong labor market and a still-large excess savings stockpile, and you have all the ingredients to keep the Fed up at night,” Vaillancourt said.
So, as long as hopes of a “soft landing” for the economy remain, the Fed will have to continue to worry about too much inflation. That increases the chances that the Fed will hike rates too far and end up with a recession.
Technicians burst into tears
Wall Street is clearly buying into the “soft landing” narrative. Take a look at how tech stocks have performed so far this year, despite a string of high-profile layoff announcements from top Silicon Valley companies over the past few months.
The Nasdaq is up 11% so far in January and is on track for its best month since July.
Some don’t think more tech layoffs will be a problem. Investors seem (somewhat paradoxically) to think that cost-cutting by companies is a good thing for profits, and that revenues may not be negatively impacted because consumers are still spending.
“One theme that can’t be ignored this month is how traders reward companies that lay off workers. With company layoffs making headlines every night, you’d think consumers were nervous. Maybe not. Demand turned out to be good,” said Ally Invest Portfolio manager Frank Newman said in a note.
“A series of well-lower-than-expected reports from these companies could dampen the market’s strong start to 2023,” Daniel Berkowitz, senior investment officer at investment management firm Prudent Management Associates, said in a note.