The Market May Not Care Yet, but This Hiring Pace Is Not Normal

The U.S. employment picture remains strong. Really strong. The Labor Department reported on Friday that the economy added 428,000 jobs. While this essentially lined up with expectations, it tells us that demand for workers remains red hot. That has major consequences for inflation, the Federal Reserve, and for markets more broadly. Here are my thoughts on what this report means for investors. Hiring's Hotter Than Normal For a while I've been assuming that employment growth would have to slow to a more normal pace for an expansionary period. After all, with unemployment at 3.6%, we are well beyond a recovery and so we should be settling into a more steady state of hiring. Historically, that's been something like 1.5%-2.5% gains on an annualized basis, which right now would be around 300,000 per month on the high end. That's the lens with which I think about the 428,000 number. No matter what the expectations were, we shouldn't lose sight that hiring is going on at an unprecedented pace for this stage of an economic expansion. The real question is, Why is this happening? It might be that the economy is simply overheating. For example, companies are trying to staff for a level of end consumer demand that isn't sustainable. It may also be that companies are reacting to how tight the labor market is and especially how many people are quitting their jobs. They may be responding by over-staffing, figuring it is better to incur the expense of having too many people than suffer the consequences of having too few and losing productivity. Remember, too, that the labor market got similarly tight in 2019 before Covid hit. Companies may be starting to assume this is the new normal for employment conditions. If so, it could cause a very happy self-fulfilling prophecy. Say that overall demand slows a bit in 2023 as Fed rate hikes start to have an effect. Companies may not be so quick to lay people off if they aren't sure they can rehire when demand returns. Wage Gains Are Solid, But Show Signs of Slowing The wage figures were a mixed bag. The year-over-year measure was 5.5%, which is right inline with the highest figures we've seen in 2021-2022. But the monthly number indicated a bit of softness, coming in at 0.3%. That would translate to a rise on the 3.8% on an annualized basis. So are wages slowing? Maybe, maybe not. If we look at the 12 major industry types that the Labor Department uses, wage gains were better than 0.3% in nine of the 12. This tells me that it is partially a mix issue. In other words, the sectors with bigger gains in employment were also ones that are on the lower end of the scale. If we look at it on a like-for-like basis, we see that wage gains remain strong and pervasive across most industries. I doubt wage growth slows in a big way until the pace of hiring slows some. At this point, the only way for employers to hire more people is to entice them, which usually means higher pay. Markets Didn't Seem to Budge All markets have been exceedingly volatile this week, and that continued on Friday. But we didn't seem to see any particular reaction to the payroll figure itself, which classically has been one of the most impactful releases of the month. The reason for this is simple: The Fed and inflation are really controlling markets right now. This release didn't change anything for the Fed, nor did it give us any fresh insights into inflation. The Fed is happy with how strong the labor market is, and therefore only a disastrously bad report would influence them in the coming months. But This Is Still Central to the Fed's Story That being said, don't sleep on how important employment is. I've talked about this sequence a lot, but I want to emphasize it again. Inflation won't subside until consumer spending slows. Consumer spending will stay high as long as income growth remains strong. Income growth is coming from wage growth. And of course, wage growth will remain robust as long as the job market is this tight. What is currently unknown is whether the Fed can manage to curb demand just enough that the labor market loosens up, but unemployment doesn't rise. Such a thing is certainly possible. Amazon recently announced it would slow hiring, saying they didn't want to chase staffing. If more firms decided to slow hiring, but not stop hiring, we'd probably get the soft landing we're all hoping for. Earlier I mentioned the possibility that tightness in the labor market could be self-fulfilling, where companies are loath to do layoffs for fear that they will struggle to staff back up later. I could see it happening where this kind of mentality helps us to get more Amazon-type responses to somewhat slower demand. But investors should realize that soft landings are tough to pull off, and no markets are currently priced well for an actual recession. I keep bringing up the possibility for a soft landing more to remind people that there is a reasonable chance of a positive outcome. It isn't a prediction though, and readers should certainly prepare their portfolio for downside risks. Bonds in a Tough Spot Bond yields have surged to new highs this week, and this has come as money had poured out of fixed income mutual funds. According to Bank of America, there were $8.2 billion in redemptions during the week ending May 4, which is the largest outflow since March 2020. These retail outflows are a symptom of a wider problem: We appear to have no real money buyers of bonds. Mutual fund and exchange-traded fund buyers aren't enticed by higher yields, and global investors don't seem interested, either. Meanwhile, we can expect no relief from the Fed. Inflation can't reasonably fall fast enough in the near-term, and the Fed won't change its hawkish tone even a little until inflation is clearly falling. They want to recover some of their lost credibility. As long as the Fed remains this hawkish in tone, it will be tough for bonds to sustain a major rally. The Fed is intentionally trying to convince people that they are willing to do anything to curb inflation, and by necessity, that means that there isn't a nearby ceiling to how high yields might go. On the flip side, as long as inflation prints stay this high, there won't be any reason for the Fed to back off, which means there's only so much downside for yields. That said, it is extremely likely that markets will overshoot in their Fed expectations, and for all we know, that's happening right now. I don't think there's a great short-term catalyst for bond yields to fall, so I don't like being long bonds as a trade, but I do think if you've been sitting in cash and intend on making a long-term allocation to bonds, this is a perfectly good entry.

The Market May Not Care Yet, but This Hiring Pace Is Not Normal

Sure, the jobs number lined up with expectations and the market didn't really budge on the big number. But let's take a close look at these figures and see why it's getting a little too hot in here.

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