Weekly Economic Trends & Indicators

The Headline

On Feb. 1, the Federal Reserve raised the federal funds rate (which is the rate at which banks borrow from and lend to each other) by 25 basis points. The target range for the fed funds rate now stands at 4.5 to 4.75%. On Feb. 3, the Bureau of Labor Statistics reported that the U.S. economy created 517,000 jobs (seasonally adjusted) during the month of January, and the unemployment rate decreased to 3.4%, the lowest unemployment rate since 1969. This increase in jobs was far above expectations.

The Details

These two big stories of the week are related. Financial markets rallied in response to the Fed’s smaller interest rate move in the hopes that the cycle of rate hikes could be ending soon. However, the unexpectedly robust jobs report for January caused a reversal in that sentiment as markets recalibrated their expectations. There was considerable divergence of opinion on whether the Fed would raise the funds rate again in March. By Friday, the market was considering another 25 basis points in March to be essentially a certainty.

The Context

The financial markets are looking for any excuse to rally, and that was borne out in last week's turnaround. The 10-year Treasury yield, which had peaked in October at over 4.2% fell below 3.4% on Thursday. Even on Friday afternoon, the yield was still at 3.5%. This is a sign that the markets believe that rate will not stay at this level for too long.

Taking a deep dive into the employment report we see that leisure and hospitality continue to lead the way. Manufacturing still added jobs, but only 19,000 which was among the lowest increases in the major categories. Corroborating that news was the Purchasing Manager’s Index from the Institute for Supply Management which has moved into contractionary territory since late last year. While everyone is certainly very excited about the job growth in January, the disproportionate strength of leisure and hospitality is hard to read. It is likely that we are still seeing that sector rebounding from losses during COVID, a process that will naturally slow down this year. Furthermore, the labor market tends to lag other economic indicators. In other words, job growth often does not reverse until we are actually in a recession. So trying to use policy to target unemployment will always cause you to be a step behind.

This all sets up a very interesting situation as the year progresses. Avoiding a recession will require near-perfect timing on the part of the Fed as to when to stop raising the fed funds rate and possibly even begin cutting. If inflation remains stubborn, rates will keep rising, increasing the risk of a more sudden decline in employment, particularly in rate-sensitive industries. We have already seen earnings misses from tech giants such as Apple and Alphabet (Google), as well as manufacturers such as Ford which could be a sign of things to come if the rate hikes continue and worldwide demand continues to soften.

Next week: Recent trends in productivity