Another Bullish Soft Landing Jobs Report With Few Inflationary Alarm Bells

The professional forecaster class has been having difficulty anticipating the non-farm payrolls (jobs report) lately, giving many commentators a run for their money. The headline numbers being so much higher than the forecast betrays a jobs report that was pretty positive in many ways. It certainly wasn't a jobs report that set off inflationary alarm bells in a significant way. So, this was actually a good report in my estimation despite the initial reaction.

This morning's report was no exception; the nonfarm payroll numbers came in at 272,000 on much more meager expectations of 190,000. Average hourly earnings were also slightly above expectations at 4.1%. The headline unemployment rate also edged into the 4-handle for the first time in two years. Some of the highlights of the report included:

• The three strongest categories of job gains were Private Education and Healthcare Services, Government, Leisure, and Hospitality.
• These three categories have continued to be the strongest over the three-, six-, and twelve-month periods.
• Within Leisure and Hospitality, most gains continued to be at bars and restaurants. Of course, the wages associated with these positions are often not inflationary.
• Coincidentally, this strength in bar and restaurant hiring at a time when lower and middle-class consumers are eating out much less supports my assertion that America's wealthiest quintile is the primary driver of inflation's stickiness.
• Job gains in healthcare are strong, but they likely have more to do with demographic changes and the general labor-related cost disease our (relatively) inefficient healthcare system suffers from than with inflationary pressure building up.
• Government hiring remains strong and is partially associated with massive fiscal investments in the economy, such as the Inflation Reduction Act and the CHIPS Act.
• Labor Force Participation was essentially unchanged. The March and April numbers were revised down slightly.

The market initially sold off on the hot jobs numbers, but I wouldn't be surprised to see a turnaround later. After many job misses, the market understands that one report doesn't alter the Fed's decision-making much. Plus, though the report was hot, there are indications that the economy is slowing , lessening the chances that labor market strength will reignite inflationary pressure.

The market responded to the report in a somewhat muted fashion. While there was some initial risk-off character, it was fading as early as about an hour into trading (when the heatmap above is from).

• Odds for the Fed not cutting rates in September jumped by about 50%.
• Yields rose, stocks fell, and high-duration stocks were hurt the most.
• The VIX was slightly down by 10:30, and the market was beginning a turnaround.
• The selloff wasn't very bad, though, because the market is realizing that the Fed is in a pretty good position and that cuts will eventually come.
• Despite the expected number of cuts dramatically dropping this year, we are still on the cusp of ATHs. This may be what I call the Fed-Amental Attribution error coming into play. We give the Fed a lot more credit for outcomes than it deserves.

Wall Street follows the jobs market and inflation numbers the closest of any major data releases. The reason is that the Federal Reserve has a dual mandate to promote optimal inflation and employment levels. These numbers provide crucial data that may alert investors to the next policy action of the Federal Reserve.

However, people often use many incorrect heuristics to assess these reports. For example, just because more jobs were created than forecasted doesn't mean the impact will be inflationary. As you can see below, many areas where jobs were created don't have the highest relative wages.

As you can see above, most jobs are being created in areas with wages below the national average. This is significant. I have been of the opinion for over a year now that the Federal Reserve's next policy move will be a cut. And I think we will have one or two cuts this year.

Risks and Where I Could Be Wrong

Inflation could reignite because two major conflicts are occurring in geographies vital to global trade. If the conflagrations worsen, they could prove very problematic for commodity prices. The nightmare scenario would be a simultaneous escalation between Iran and Israel and between the West and Russia. Both events could cause significant spikes in prices that could reverberate throughout the global economy in a very negative way.

One potential risk is that the seasonality of gasoline prices is trending upward, and these are always a major psychological driver of how consumers perceive and respond to inflation, even if gasoline is a lower portion of the consumer's wallet than in the past. Further risks could derail the economy as well:

• Commercial real estate blow-up causes a credit event.
• Inflation continues trending higher or staying put.
• Increased political risk during an election year.
• Fed policy error or banking crisis reignites.
• A strengthening US dollar could prove a headwind for earnings next quarter.

There are other risks besides inflation, like those above, of course. A recession for any reason is bad for stock market earnings, and there are no shortages of potential causes looming. However, I like to remember the saying that markets climb a wall of worry and fall on a slope of hope. I see no shortage of worries.

Conclusion

Much of the bearish unwillingness to see the positive in our post-COVID economic recovery may be rooted in ideological fealty to Monetarism. -April Nonfarm Payrolls: Worse Than Expected News Is Good News, Chris Robb

For many consecutive months, the job numbers showed a strong mismatch in the labor market and consistently came in much stronger than expected. However, the inflationary elements of wage measurements suggested that renewed inflationary pressure from labor market strength was unlikely.

This is because wages are outpacing inflation, so the behavioral spiral of consumers trying to purchase items before anticipated price rises is much harder to set off. This behavioral spiral is the primary thing the Federal Reserve wants to avoid with its powerful policy tools. Without the prospect of reigniting inflation, a strong jobs report is just simply good news. The economy is undergoing a soft landing after an amazing post-pandemic recovery, and curmudgeonly bearish commentators have tied themselves in ideological and rational knots to try and explain why our strong post-pandemic economy is bad.