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Market Update

Strong October Job Report Sets the Stage for Continued Fed Rate Increases

Moderate wage growth a good sign for inflation, but CPI reports will determine the Fed’s path.

Defying expectations for a slowdown in hiring, the job market continued to chug along at a robust pace in October, making it likely investors will have to contend with continued interest-rate increases by the Federal Reserve.

The October jobs report from the Bureau of Labor Statistics showed total nonfarm payrolls rose by 261,000. That was well above the consensus forecast for a rise of 200,000, according to FactSet. Job gains were led by healthcare, professional and technical services, and manufacturing. While the October increase in job creation was down from the 315,000 new jobs recorded for September, by historical standards, hiring remained strong.

The jobs report comes just two days after the Fed raised interest rates by 0.75 percentage points for an unprecedented fourth consecutive meeting, taking its target for the federal-funds rate to 3.75%-4.00%. Following the latest Fed meeting, Fed Chair Jerome Powell said that given the continued high level of inflation pressures and strength of the economy, it would be “premature” for the Fed to be thinking about pausing its rate hike efforts.

Still there were some hints of moderation in the jobs report, says Preston Caldwell, chief U.S. economist at Morningstar. “Nonfarm payrolls increased by an average 0.2% in the three months ending in October, compared to 0.3% in the three months ending in July. Thus, a slight downtrend is discernible,” he says.

“The job market does appear to be slowing, but not fast enough to seriously alter the Fed’s decision-making on upcoming rate hikes,” Caldwell says. “Of course, labor markets do tend to lag the economic cycle, supporting our view that job growth is likely to slow greatly over the next few quarters.”

Caldwell points to moderate wage growth as reason to expect inflation rates to come down, but adds “ultimately the Fed is going to wait until progress is made in the actual inflation data before considering a major pivot in policy. The November and December CPI releases will be the main determinants of the Fed’s next rate hike decision.”

All nonfarm employees

The Fed has been on an aggressive path of raising interest rates this year, looking to push inflation down from a four-decade high by slowing the economy. The jobs market is a key focus for the Fed, as strongly rising wages act to support high inflation rates. Signs of a cooling off in hiring are central to the Fed being able to slow, and eventually end, its interest rate increases.

After the release of jobs report, market expectations for the Fed’s upcoming December meeting were evenly split between another aggressive 0.75-percentage-point increase in the federal-funds rate target and a smaller, but still aggressive by historical standards, 0.50-percentage-point hike. Expectations of a small 0.25-percentage-point hike were taken off the table for December, according to the CME FedWatch tool.

% probability for federal-funds rate level

In addition, the bond market is signaling expectations that the Fed won’t be done raising rates until the spring.

Based on majority expectations for the Fed’s funds rate target, the Fed is seen lifting its target to 4.75%—5.00% at January’s meeting, and then another 0.25 percentage points. After that, the Fed is expected to hold rates steady till late in the year.

Upper limit of the federal-funds expected target rate at future Federal Open Market Committee meetings.

While payrolls growth was stronger than had been expected, the unemployment rate also rose. The payrolls figures and the unemployment rate are based on different datasets and can at times show slightly different trends.

The latest jobs report revealed a rise in the unemployment rate to 3.7% in October. The unemployment rate has been in a narrow range of 3.5%-3.7% since March, the Labor Department said.

“The unemployment rate ticked up to 3.7% from 3.5% because it is based on the household measure of employment—which actually decreased by about 300,000 in October, in contrast to the headline nonfarm payroll gains,” Caldwell says.

Monthly changes in the unemployment rate since January 2020

Underlying the rise in payrolls, healthcare jobs rose by 53,000 in October. The Labor Department said that healthcare employment has on average risen by 47,000 per month in 2022, compared to just 9,000 per month in 2021.

Leisure and hospitality added 35,000 jobs for the month, but employment in the sector is still down 1.1 million jobs from February 2020 prepandemic levels.

“Job gains have been fairly broad-based by industry, though with some exceptions,” Caldwell says. “Construction employment was about flat over the past three months, evincing the impact of the slowdown in housing activity. Retail employment also has been flat, as consumer spending on goods has slowed somewhat.”

3-Month increase

With the Fed’s focus on wage growth, the jobs report painted a mixed picture. Average hourly earnings rose 0.4%, up from a 0.3% increase in September. But on a year-over-year basis, wages showed some deceleration. Average hourly earnings rose by 4.7% over the past year, down from the 5.0% annual increase registered in September.

Month-to-month change in wages compared to 3-month rolling average numbers.

“With job growth persisting at normal levels for now, the report doesn’t call for an abrupt pivot in Fed monetary policy,” Caldwell says. “On the other hand, private wage growth averaged 3.9% in the three months through October. This is consistent with inflation of about 3% or lower, far lower than the 8.2% year-over-year increase in the Consumer Price Index in September.”