Markets were forced to re-price the timing of interest rate cuts again last week after strong ISM manufacturing and labor market data pointed to an economy that is re-accelerating. Entrenched structural inflation becomes a greater risk as economic activity rides positive momentum, likely forcing the Federal Reserve to keep financial conditions tight. With several Fed Governors speaking last week, the rhetoric pointed towards voting members keeping a bias towards holding rates at current levels for longer. While there is no apparent desire for a rate hike, the probability of a rate cut is being pushed further into the future. Economic strength should be viewed as a positive for asset prices, generally; however, higher interest rates could pose a larger headwind to future growth. The gravity of interest rates outweighed the prospect of future growth last week for investors as the equity market posted the worst week since early January. The S&P 500 Index closed lower by 0.9%, while the US Aggregate Bond Index traded lower by 1.1%, as rates moved higher across the yield curve.
US Payrolls Surge the Most Since May 2023
Monthly nonfarm payrolls vs unemployment rate
Source: Bureau of Labor Statistics. As of Mar 31, 2024.
According to Friday’s Bureau of Labor Statistics report, US payrolls added 303k in March, the largest increase in nearly a year. The figure handily beat economist expectations of 214k, while the prior month was revised 5k lower and January revised 27k higher. Job growth in March was led by hiring in health care, construction, and leisure and hospitality, which has now bounced back above its pre-pandemic level. The strong report included a 0.1% drop in the unemployment rate to 3.8% and a labor participation rate increasing to 62.7%, up from 62.5%. A 0.2% increase in labor participation may not seem like much, but it equates to more than 700k new workers or people looking for work. The rise in participation will be positively received by Federal Reserve Officials, as they aim to control wage increases and its potential impact on inflation. The labor market has been the stalwart of the US economy, giving Americans spending power amid higher prices and borrowing costs. Fed officials have flagged a moderating labor market as a prerequisite for rate cuts, but the recent strength will throw timing into question.
Earnings Transcript Mentions: Jobs Cuts vs Labor Shortage
Source: Bloomberg AI-Powered Earnings Call Summaries. As of Mar 31, 2024.
Investors are torn between wanting a strong economy to support further corporate earnings growth and wanting a weaker jobs market that will lead to rate cuts. Looking through past earnings transcripts, management impetus to add more jobs is waning as the focus on capital efficiency remains a higher priority. Assuming this leading indicator is durable, the recent strength in labor markets could mark a top. With the next earnings season right around the corner, investors will get an update on how US corporations think about future growth prospects.
Probability of June 2024 Interest Rate Cut
Based on Fed Funds Futures
Source: Bloomberg.
– Written by Eric Schmitz, CFA