How the Latest Job Report Could Influence the Fed’s Decision on Funds Rate

December's jobs report may be strong, but the labor market is yet to catch up with recessionary forces.

Defying expectations, the latest job report for December shows a rise in employment by 0.2%. Likewise, nonfarm payrolls increased over the Dow Jones forecast to 223,000. Given the Fed’s emphasis on the labor market to determine federal funds rate, are rate cuts on the table in the near future?

What Does the Latest Job Report Tell Us?

Per the monthly schedule, the US Bureau of Labor Statistics delivered another labor market report. December’s data shows a decrease in the unemployment rate, now at 3.5%, a 0.2% decline from November. This was better than the Federal Reserve needed to cool down the economy, i.e., keep the inflation rate down.

Beating Dow Jones’ estimate for 200,000 nonfarm payrolls, December shows an increase of +23,000 instead. However, this still represents a decrease from November’s 256,000 nonfarm payroll gains. Nonfarm payrolls measure the influx of new paid labor, excluding government employees, farm workers, and non-profit and private household employees.

All Employees, Total Nonfarm Chart

Zooming back to the Great Recession of 2008 and lockdowns, the labor market continued the interrupted February 2020 trajectory. Image credit: fred.stlousfed.org

The only weakening in December’s data comes from lower-than-expected wage growth, at 4.6% compared to November’s 5.1%. This underperformed the estimate of 5%, while average hourly earnings climbed by 0.3% instead of the estimated 0.4%. Although dampened wage growth indicates that inflationary force is waning, some Fed members are not interpreting this as a reason to halt rate hikes.

“I’ve been looking for the economy to continually slow from the strong position it was at in the summertime. This is just the next step in that.”

Atlanta Fed President Raphael Bostic on December’s lower wage growth

Breaking down these numbers into sectors, the hospitality and leisure sector had the most significant gains, adding 67,000 extra jobs. Healthcare gained 55,000, construction 28,000, and social services 20,000 new employees.

Lastly, the labor force participation rate went up to 62.3%, which is still below the economic cleavage in February 2020 by a single percentage point.

The Fed’s Reliance on the Labor Market to Gauge Interest Rate Hikes

It is no secret that, in times of high inflation, the Federal Reserve needs to cool down the overheated economy. This translates to a weakened labor market, which December’s data doesn’t show.

In the FOMC minutes released on Wednesday, Fed officials agreed that the federal funds rate should stay in restrictive mode, possibly climbing to 5.4% during 2023, from December’s 4.5%. Much of this outlook is dependent on the labor market. Specifically, job availability that allows for public consumption. In November, one could count on 1.7 job openings for every worker.

With that said, the labor market is typically a lagging indicator. That’s because, in a growing economy, businesses meet increased demand, which aligns with more hiring. However, it takes time for these market signals to follow through and manifest as increased employment.

In the opposite direction, when the economy is slowing down and the inflation rate is decreasing, lowered demand leads to layoffs. This has been playing out in the Big Tech sector for several months, as Layoffs.fyi tracking aggregator shows the loss of 150,000 jobs during 2022. The tech sector is a more agile market, so layoffs are yet to show up in the economy at large.

“Despite remaining strong in 2022, the labor market is poised to weaken in 2023, as it’s a lagging indicator of which medicine takes the longest to cure,”

José Torres, Interactive Brokers senior economist

According to December’s Bloomberg poll, 7 of 10 economists forecast a recession in 2023. This outlook also aligns with BlackRock’s Global Investment Outlook. Likewise, the International Monetary Fund (IMF) warned of a global recession this week, hitting half of the EU and one-third of the world.

Crude oil prices, as a more responsive economic indicator, already show a -5.71% year-over-year drop. The US economy exited 2022 with a +3.8% GDP growth rate, so the Fed will likely increase the rate by another 25 bps to boost the cooldown process. Presently, the market places a 76% probability for that to happen at the FOMC’s next meeting on February 1st.

Crypto to Likely Follow Stocks

In a recessionary environment, the stock market typically goes down except for consumer staples like Walmart (NYSE:WMT), Costco Wholesale (NASDAQ:COST), or Unilever (NYSE:UL). After all, decreased consumer spending leads to more selective spending, lower earnings, and reduced shareholder dividends. This also creates a risk-averse investor mindset, triggering selloffs.

Given that cryptocurrencies are on-risk assets, they typically correlate with the stock sentiment, be they optimistic or risk-averse. In this light, the crypto market should rely more on specific events and news than a favorable macro environment.

Moreover, there is still much uncertainty surrounding Silvergate and Digital Currency Group, the biggest players in the centralized part of the crypto space. If they follow FTX, more selloffs could be underway.

In such unstable times, crypto investors seek refuge in the most significant cryptocurrencies – BTC and ETH. Indeed, since the FTX crash in November, they have primarily flatlined, at -3.3% and-1.6%, respectively.