Weekly Market Perspectives: More rate hikes to come?

Published: July 8, 2023

In a holiday-shortened week, markets traded lower following hawkish comments/minutes from the Federal Reserve Board of Governors and a mixed pair of labor market reports. The S&P 500 ended the week lower by -1.1% and the US Aggregate bond index traded lower by -1.3% driven by higher yields across the curve as markets price in a higher probability of more rate hikes. The economy continues to churn out positive data, but investors continue to grapple with the ominous predictions of a looming recession and a hard landing.

First, the Federal Reserve minutes from the previous meeting that were released on Wednesday showed that several members reluctantly consented and voted for the recent pause in interest rate hikes. Critical to this compromise was communicating to the market that more rate hikes were going to be needed and a plan to leave rates at current levels or higher. The key point of contention is that core inflation (excl. food and energy) continues to be very sticky, modestly budging from the 5%+ level since the start of the year. While monetary policy flows through the economy on a notable lag, the fastest tightening cycle in decade that started at the beginning of 2022 is still not seen as enough to contain high prices and investors are growing more concerned that a recession will be needed to reach the Fed’s stated target.

Second, the labor market is showing mixed signals but likely still remains too robust for the Fed’s comfort. Following a blowout ADP report on Thursday which showed exceptional gains in private payrolls (adding nearly 500k jobs vs 225k expected), the non-farm payrolls report on Friday from the Bureau of Labor Statistics showed the labor market added 209k jobs, coming in below expectations for the first time in 15 months. Even though the report missed expectation, the economy has consistently added 200k+ jobs every month since December 2020. In addition, year-over-year wage growth remains robust near 4.4% – a closely watched input to consumer inflation. The trend for job creation and wage growth still remains solid, but there are a few cracks showing.

US hiring is trending lower and that includes in job openings becoming increasingly less available in certain industries. The chart below shows that fewer industries are adding new employees than at the start of the year although the number suggests most industries are still adding to headcount. The top contributors to the recent gains in employment include healthcare, government, construction, leisure/hospitality, and professional services. Perhaps one area that would give the Fed additional impetus to hike rates is the net new additions in cyclical industries.

May’s report on job openings and labor turnover showed the number of vacancies per unemployed worker – a key indicator of market tightness for policymakers – fell to 1.6 from 1.8 but continues to indicate that demand for labor outstrips supply. Separately, the quits rate ticked higher indicating that workers are feeling confident of finding a new job soon after leaving their last job.

The “higher for longer” messaging from the Fed became more entrenched this week and that is beginning to influence investor expectations. At this point, all members of the Fed expect to raise rates further in 2023 and leave them higher through 2024. Conflicting with this positioning is that the Fed expects the economy to enter a mild recession later in 2023. This dynamic of raising rates into anticipated economic weakness is very unusual.

Source: Bloomberg