Well Wall Streeters, which is it? Do we want a strong economy, or low rates? The data that the Federal Reserve uses to determine interest rates refuses to relent. That should be great news as it means that despite the most rapid rate cycle in history, the economy remains resilient. Last week, the United States Department of Labor released their latest Non-Farm Payrolls report and like most of them since the depths of the pandemic, the report was above pre-pandemic averages and unemployment continues near historical lows.
Interestingly, job growth was broad as all sectors except for Information Technology and Manufacturing. While those two shouldn’t surprise us, the breadth of strength definitely does. As a reminder, the Federal Reserve has two major mandates: keep inflation in check and encourage high employment. One of those is working great….the other? It’s a disaster. Increasing interest rates and messaging that process to Wall Street is no simple task, but given the problems at the banks, it is widely believed that the Fed will pause interest rate hikes at the next meeting. We suspect that they will, but many capital markets participants have been under the impression that when the rate hike cycle ends, we should see rate cuts almost immediately after their first pause. This is an unlikely scenario and getting more so by the day.
The data (since they are data dependent) tells us that employment numbers continue above trend, and the inflation numbers, suggest the same. Can the Fed really stop raising rates with inflation numbers well above trend? Maybe they can slow, but they certainly can not cut. Until the data suggests that inflation can trend toward the 2% target, it is more likely that the Fed will increase rates. Which brings us back to Wall Street….why would the market go up on good data if it really means bad things for rates? We think the positive stock market reaction was most likely about traders being scared to be short into the weekend with the debt ceiling debate coming to a conclusion, but maybe….maybe Wall Street was happy to see a reset of expectations for rates in the back half of 2023.