Decoding the September jobs report: Implications for the Fed and interest rates

The US economy added 336,000 jobs in September. That was well above economists’ expectations and broke a three-month streak of relatively weak payroll gains. 

Does this mean the labor market is heating back up? And does it mean the Federal Reserve may have to start hiking interest rates again? 

Here are our thoughts on the state of the labor market.

Strong job gains, upward revisions

Any way you slice it, the September job gain was impressive. According to Bloomberg, economists had been expecting job growth to slow slightly from August. Instead, the September gain was the largest single-month gain since January on its own, plus the prior two months were revised upward by 119,000. 

Before this release, it appeared job growth was on a downward trend. Now, with both the September figure and the upward revisions, it looks more like job gains are stabilizing.

Source: Bureau of Labor Statistics

Looking at the graph above, you can see that job gains bounced around quite a bit. There were a few big spikes, like the one in January of this year, that either got revised away later or just didn’t follow through in subsequent months. 

The same goes for dips like the one we saw in June. This serves as a reminder not to get too excited or down about any given month’s payroll number. Rather, consider it just one piece of a broader employment puzzle.

Is hiring demand actually heating up?

Given this point, the question becomes, is hiring accelerating? Or does the September jobs report merely reflect normal variation around a sideways trend? 

We can look at a wider range of employment statistics to ascertain this. First is the Job Openings and Labor Turnover Survey, also called JOLTS. This report showed that job openings rose in August but are still lower than three months ago and down 6% since this time last year.

That same report shows the rate of workers quitting their current jobs. Readers may remember that in 2021-2022, there was talk of a “Great Resignation” where so many employees quit to take other jobs looking for more money and/or a more favorable work environment. That rapid increase in the quit rate would only occur in a scorching job market. We now see that the quit rate is back to 2018-2019 levels.

Source: Bureau of Labor Statistics

Data from private firms also suggest that the labor market has cooled. LinkedIn’s State of the Labor Market report estimates that US hiring declined by 3.6% in August and is down 23.8% over the last year. Job search firm Indeed tracks employer job postings on their website, and that data indicates postings have declined by 1% since July and down 15% over the last year.

Adding all these data sets together, it does not appear that hiring is actually accelerating. Our interpretation is that labor demand is still strong but steady. There are also some promising signs that this level of labor demand is sustainable without creating more inflation pressure.

Wage growth weaker than expected

One reason to believe today’s level of labor demand isn’t inflationary comes from recent wage data. Despite overall job increases well above expectations, wage growth was lower than economists anticipated. The chart below shows that year-over-year wage growth has cooled from almost 6% at the start of 2022 to just over 4% now.

Source: Bureau of Labor Statistics

The orange line represents wage growth over the last three months annualized. Here, we see that if the trend of the last three months keeps up, wage growth will be running very close to the pre-COVID trend. 

This is important for inflation. Prices can’t keep rising unless consumers spend more. Consumers can’t spend more unless they have more income to spend. So, if wage growth is running around 2019 levels, it stands to reason that inflation will also return to 2019 levels.

What does this mean for the Fed?

In the days since this jobs number was released, some Fed officials have indicated they are less likely to hike rates again in 2023. Most notably, Fed Vice Chair Phillip Jefferson said in a speech on October 9:

“My view is that the FOMC is in a position to proceed carefully in assessing the extent of any additional policy firming that may be necessary.” 

Note that not all Fed speakers are equal. The Fed’s policy committee consists of two groups: The regional presidents who oversee each of the Fed’s 12 districts, and the Fed Board, which operates out of Washington DC and includes Chair Jerome Powell, Vice Chair Jefferson, and five others. 

Regional presidents are generally free to speak their minds when giving public speeches, which may or may not reflect how other committee members feel. On the other hand, board members are in much closer contact with Chair Powell and rarely will say something out of step with what the Chair thinks. 

In addition, board members know the market is listening closely to every speech, so they craft their words carefully. Jefferson would not use a phrase like “proceed carefully” unless he felt that it was more likely than not that the Fed would hold off hiking at their next meeting on November 1st.

So what gives him that much confidence, even in the face of this outsized employment gain? A lot of it is probably that Fed economists are doing the same analysis we did above. However, it is also the fact that longer-term interest rates keep rising. 

Since August 31, the 10-year Treasury yield has risen from 4.1% to as high as 4.8% despite the fact that the Fed has not hiked at all during that period. This takes some pressure off the Fed. Remember that the Fed can only directly set the interest rates for the banks it transacts with, and still, these are only overnight rates. 

Longer-term rates, such as corporate borrowing rates or home mortgages, are influenced by the Fed but not directly set. Higher long-term yields arguably have a bigger impact on the real economy than short-term rates. 

Jefferson cited this factor in that same speech:

“Looking ahead, I will remain cognizant of the tightening in financial conditions through higher bond yields and will keep that in mind as I assess the future path of policy.”

He is saying that higher yields on longer-term rates are functioning like an additional Fed hike or two. That may negate the need for further hikes. 

Good news is still good news

What does this mean for your portfolio? As we said above, longer-term interest rates have been rising the last few weeks despite no action from the Fed. Therefore, it goes without saying that bond yields can rise all on their own. However, there is a limit to this. 

The most significant factor that drives longer-term bond yields is anticipated future Fed policy rates. In fact, the main reason why longer-term Treasury bond yields have risen recently is traders are now assuming the Fed will keep their target rate higher for longer. 

A simple way to think about the proper rate for a 10-year bond is that it should be roughly equal to the average Fed target rate over those ten years. If the Fed is going to keep its target high for a long time, it makes sense that longer-term rates should rise. That said, it would be very difficult for 10-year yields to rise above the current Fed target rate.

Why? Because that would suggest the Fed will never cut rates.

Even though recession risk seems to have diminished, we know eventually, a recession will hit, and whenever that happens, the Fed is likely to cut rates. In other words, if today’s Fed rate is the peak for this cycle, and if the Fed is going to ever cut rates again, then longer-term yields should be lower than short-term yields.

So we don’t know when long-term bond yields will stop rising, but we do know they can’t climb forever. Add to that the fact that the yields on bonds are higher than at any time in the last 15 years. That means that even if interest rates just stay steady, the return on bonds should be pretty strong.

For stocks, good news is still good news. Stocks have struggled a bit in the last few weeks amidst the spike in longer-term rates. This makes sense if you consider that any company with outstanding debt is probably facing higher interest costs in the future. However, we know that if the economy remains strong, companies will keep growing profits, ultimately overwhelming any minor increase in interest costs. 

Facet’s portfolios specifically are underweight companies with high debt burdens, and thus, we feel our portfolios are at least somewhat protected should rates remain this high for an extended period.