(CNN) — It’s not the fall that kills you, as the saying goes — it’s the sudden stop at the bottom.
Friday’s solid jobs report sent Wall Street reeling after it reignited concerns that the Federal Reserve will continue on its unprecedented campaign of hiking interest rates in the face of sustained high inflation.
Despite reports of companies slashing head counts, job growth in September clocked in at a solid 263,000, along with an upward revision of 11,000 for July. Meanwhile, the unemployment rate ticked down to 3.5% from 3.7%. Solid job gains and low unemployment are generally considered positive news, but when coupled with above-average wage growth and anemic labor force participation, the calculus changes.
The upshot? What would normally be “good news” suddenly looks bad.
The central bank has been trying to slow the economy through a series of aggressive rate hikes, but the labor market’s continued resilience may force it to raise rates even further — a move that could result in job losses, said Bill Northey, senior investment director at U.S. Bank Wealth Management. For investors accustomed to policies that stoke the economy, this can create dissonance. “We’re stuck in this odd dynamic,” Northey said.
“The Fed certainly doesn’t want the job market and the economy to collapse. What they’re trying to do is manage that decline,” said Scott Ladner, chief investment officer at Horizon Investments. “What they really want to see is things getting marginally weaker.”
But that is a delicate balance to pull off under optimal conditions and, to date, evidence of that weakness has been hard to find. The number of job openings in August dropped by an unexpected 1.1 million, but the number of available jobs still far outpaces the number of job seekers, with roughly 1.7 jobs available for every unemployed worker.
“If [the Fed] could engineer a slowdown, their preferred path would be to keep a solid labor market, but cut the number of job openings,” said Quincy Krosby, chief global strategist at LPL Financial.
Fewer job openings aren’t enough of a release valve to take the pressure off wage gains, though. Demand for workers feeds into higher inflation as companies raise pay to attract talent and, to a somewhat lesser degree, retain it. Wage inflation is particularly feared by economists because once established, it is rarely unwound.
“It’s possible we’ve seen the peak in the inflation rate, but I don’t know if we’re close to getting inflation back to 2%. And that’s the disconnect,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance. “There’s a big difference between peak inflation and inflation back to 2%.”
The core Personal Consumption Expenditures price index, the Federal Reserve’s preferred inflation gauge, rose by 0.6% in August, catching economists — who had predicted it would take a breather for the month — by surprise.
“The problem is the consumer is employed and the consumer has savings,” Zaccarelli said. “Normally, those are great things. However, when inflation is a problem, both of those things are at odds with reducing inflation.”
The Fed faces a ‘Hobson’s choice’
“From a market participant standpoint, [Friday’s jobs report] means the Fed is not likely to slow their pace of rate increases any slower than previously communicated,” Northey said, an outcome that triggered declines across all three major stock indices on Friday.
Krosby said Wall Street’s outlook can skew overly rosy sometimes, in spite of a parade of Fed officials reiterating the firm anti-inflation stance articulated briefly and bluntly by Fed Chair Jerome Powell at the central bank’s annual symposium in Jackson Hole, Wyoming, in August.
“He’s been very clear he doesn’t want to stop and watch to see how the economy unfolds and pause again,” Krosby said, noting Powell’s frequent reference to the sustained inflation that it ultimately took a deep recession to shake in the early 1980s.
“This is not a science, and that makes investors concerned.”
Worry about higher interest rates tanking the economy and sending stocks into a protracted swan dive might be preoccupying Wall Street, but rate angst makes for a strange bedfellow. The Fed is also taking heat from sources decidedly less friendly to Wall Street: “Do you know what’s worse than high prices and a strong economy is high prices and millions of people out of work. I’m very worried that the Fed is going to tip this economy into recession,” Senator Elizabeth Warren, Democrat of Massachusetts, told CNN’s State of the Union in August.
Teasing out the implications of what this might mean for individual households is inevitably fraught, since the financial “pain” Powell has invoked in recent remarks is bound to fall unevenly.
“I think there’s no doubt that in the short run, losing your job is much worse than having higher prices, and that’s why the Fed has a Hobson’s choice, in that both outcomes are bad,” Zaccarelli said.
In electing to keep rates high and policy tight, the central bank is betting that the pain of job losses will ultimately be less than that of 1970s-style inflation, Zaccarelli said. “What the Fed has learned from history is that when inflation is high and it remains high, it hurts everyone, whether you’re employed or unemployed.”
This is the conclusion policymakers seem to have reached, and — so far at least — seem committed to maintaining.
“They are staying on message completely,” Krosby said. “If they pause and wait and watch and inflation isn’t expunged… they will go into the history books as a team akin to Arthur Burns,” who led the Fed from 1970 to 1978 and failed to tame inflation. “I think they realize this is their legacy.”