In the Federal Reserve’s (FED) fight against inflation, the labor market has proven to be a worthy adversary.   As we’ve discussed numerous times in this newsletter, the FED is targeting an unemployment rate of 4.5%.  (For reference, the unemployment rate was 3.8% in August 2023.)  They feel that this will reduce demand on the economy, which will help bring inflation back under control.  The labor market continues to be crucial to this economic recovery.

Just a quick reminder:  These articles I share here are researched and written by me!  As part of my commitment to ongoing support for my clients and partners, I write these articles to help them understand what’s really happening in the markets, beyond the headlines and soundbites.

The FED’s wishes
Since the FED has been open about their target unemployment level, financial markets have taken the FED at their word.  For better and for worse, markets have reacted strongly to the unemployment and jobs reports for the last several months.  Reports that show a strong labor market have generally caused a downturn in the markets, while reports that show a softening labor market have caused markets to rally.  We can see that markets expect the FED to continue to hike interest rates until unemployment rises closer toward their goal of 4.5%.

The reality of the labor market
But the composition of this labor market may not allow for an unemployment rate of 4.5% without triggering a job-loss recession.  As we noted in our last newsletter, there are currently far more job openings than there are people looking for work.  The last two jobs reports have shown a narrowing gap between job openings and people looking for work, which is promising for interest rates.  For a FED that’s intent on seeing unemployment rise – and financial markets who believe them — this is a promising sign.

What to watch for
There are a few important metrics to watch right now that can tell us if the FED will continue to hike rates or if they’ll pause:  The unemployment rate, of course, but before that, we’re keeping an eye on the delta between job openings vs. people looking for work.  If we get jobs data that shows that gap is narrowing, mortgage rates to get some relief.  However, if that delta widens, we should expect rates to climb.

The short story
The FED says it wants higher unemployment to bring down inflation.  I am not convinced that’s necessary.  Due to the makeup of this labor market, many analysts believe that the FED can get a hold on inflation without pushing the US into a job-loss recession.  However, only time will tell.

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