November Employment Report and the Fed

The stock market could be constrained going into the December 13-14 FOMC Meeting, weighed down by fears that the stronger-than-expected November Employment Report will keep the Fed on an aggressive path.  But, the economy is slowing, which supports a less aggressive approach to policy tightening.  So, a downshift in rate hikes to 50 BPs from 75 BPs remains likely.  The economy is not slowing enough as yet, however, to ease labor market conditions sufficiently to hold down inflation on a sustained basis.  The endpoint of this tightening cycle will likely be raised as a result.

The problem with the November Employment Report was not so much that Payrolls came in stronger than expected but that wage inflation remained high.  Payrolls slowed in November relative to October, which was consistent with the implications of the Unemployment Claims data.  The latter and other evidence, including the decline in the November Average Workweek, at this point suggest Payrolls will slow further in December.  However, the November pace is still well above the desired 100k mentioned by Fed Chair Powell in his speech last week.  Moreover, Retail/Warehousing/Courier jobs fell, suggesting lower-than-normal holiday hiring that will reverse in January.

Other components of the Report also point to slower economic activity.  With the Average Workweek down last month, Total Hours Worked (THW) fell m/m.  THW look like they slowed to 0.9% (q/q, saar) in Q422 from  3.0% in Q322.  The Unemployment Rate also suggests some weakening in economic growth.  While the Unemployment Rate was steady at 3.7% in November, it remained slightly above the 3.6% Q322 average.   The Atlanta Fed model's estimate of Q422 Real GDP Growth is down to 2.8% from 4.3%.  But, even this pace may understate the degree of slowing in the economy.  The m/m trajectory of THW shows a slowdown over the course of Q422.  It enhances the possibility of slower GDP Growth in Q123.

The problem for the Fed and the markets is that wage inflation picked up in the past two months.  Average Hourly Earnings (AHE) rose 0.6% m/m in November after an upward-revised 0.5% in October (was 0.4%).  Both are above the prior 0.4% m/m trend.  The November increase was widespread, with 8 of the 13 major sectors speeding up.  Nevertheless, the overall November speedup could have resulted from the extraordinary jumps in Transportation/Warehousing and Information  (+2.5% and +1.6%, respectively).  A simple average of the AHE sectoral changes excluding these two yields +0.4% in November versus +0.5% in October.  Moreover, the Transportation/Warehousing AHE surge could reverse after the holidays.  So, there may be less than meets the eye in the large overall AHE increase in November.

In his speech last week, Fed Chair Powell cited the "uncertain lags" between monetary policy and growth and inflation.  And, wage/price inflation tends to lag policy more than does growth.  So, the combination of an economic slowdown with still high wage inflation is to be expected.  Powell also mentioned that excess demand for labor could be exerting upward pressure on wages.  And, the Fed is aiming to restore balance in the labor market.  These comments imply that economic activity has to slow even more than it already has, if not decline, to bring wage inflation under control.  The Unemployment Rate probably has to rise at least a percentage point to do so.

Nonetheless, the slowdown in economic growth, as seen in THW, should encourage the Fed's belief that the tightening to date is having an effect.  So, officials could feel comfortable downshifting rate hikes to 50 BPs from 75 BPs.  At the same time, the failure of wage inflation to respond as yet argues for the Fed to raise its expected terminal point, pointing to more rate hikes next year than it had penciled in at the September FOMC Meeting.

Looking ahead to the November CPI, due December 13, a relatively moderate but still above-Fed target print is a good possibility.  A slight speedup in the Core CPI from October's +0.3% m/m can't be ruled out.  Among the components, Used Car Prices and Medical Care Services are not likely to subtract as they did in October.  And, Owners' Equivalent Rent may not slow again: while the lagged effect of the rent slowdown should continue to pull it down, there could be a smaller subtraction from the energy adjustment in its calculation this month.  Food Away from Home and Lodging may continue to be lifted by higher wages.  AHE in the Retail and Lodging sectors sped up in both October and November.