Is the Fed Willing to Sacrifice the Market and Economy to Tame Inflation?

Samantha Subin and Sarah Min of CNBC report the Dow closes 400 points higher, but snaps four-week win streak on rising rate fears

Stocks rallied on Friday, but finished the week lower, as investors drew conflicting conclusions about what the latest payroll numbers mean for future Federal Reserve rate hikes.

The Dow Jones Industrial Average gained 401.97 points, or 1.26%, to close at 32,403.22. The S&P 500 advanced 1.36% to settle at 3,770.55, and the Nasdaq Composite rose 1.28% to finish at 10,475.25.

All the major averages capped off the week with losses. The Dow shed 1.4%, ending four weeks of gains. The S&P and Nasdaq fell 3.35% and 5.65%, respectively, to break two-week winning streaks.

October’s nonfarm payrolls report on Friday left investors divided, fueling some concern that the Fed will persist with its hiking campaign since the labor market added 261,000 jobs. Others interpreted the findings as a sign that the labor market is beginning to cool — albeit at a slow pace — since the unemployment rate rose to 3.7%.

“You see kind of a tale of two cities today,” said Anthony Saglimbene, chief market strategist at Ameriprise Financial. “I don’t think the market quite knows how to gauge this employment number versus what the Fed signaled on Wednesday.”

Investors in recent days have struggled to decipher comments from Fed Chair Jerome Powell regarding whether a tightening pivot may come as the central bank fights to tame rising inflation and a strong economy. Focus also shifted toward next week’s consumer price index report. A drop in inflation could signal rate hikes are doing their job and fuel a potential shift.

In other news, hopes of a reopening in China pushed shares of U.S.-listed China stocks higher Friday, although the government hasn’t formally announced a pivot. Pinduoduo, and Alibaba shares surged.

Corporate earnings season also continued, with mobile payment company Block surging 11% after beating expectations. Carvana shares dropped 38% as it posted a wider-than-expected loss, while Twilio and Atlassian both plummeted on disappointing guidance.

Along with Thursday’s CPI report, investors are looking ahead to next week’s midterm elections.

It was another volatile week on Wall Street as the Federal Reserve hiked rates once again and this morning we had the US jobs report for October.

Let me begin with the US jobs report. 

Lucia Mutikani of Reuters reports US job growth strong in October, but cracks emerging:

U.S. job growth increased more than expected in October, but the pace is slowing and the unemployment rate rose to 3.7%, suggesting some loosening in labor market conditions, which would allow the Federal Reserve to shift towards smaller interest rates increases starting in December.

The Labor Department's closely watched unemployment report on Friday also showed annual wages increasing at their slowest pace in just over a year last month. Household employment decreased and the employment-to-population ratio, viewed as a measure of an economy's ability to create employment, for prime-age workers fell by the most in 2-1/2 years.

"The foundation of the labor market strength story fades a little when you pull back the tarp and look more closely at the details," said Christopher Rupkey, chief economist at FWDBONDS in New York. "The report to us looks like payroll jobs growth will falter in coming months as companies batten down the hatches as the Fed continues to take away the economy's punch."

The survey of establishments showed nonfarm payrolls increased 261,000 last month, the smallest gain since December 2020. Data for September was revised higher to show 315,000 jobs added instead of 263,000 as previously reported.

Employment growth has averaged 407,000 per month this year compared with 562,000 in 2021. Economists polled by Reuters had forecast 200,000 jobs, with estimates ranging from 120,000 to 300,000. Still, the labor market remains tight, with 1.9 job openings per unemployed person at the end of September.

The government said Hurricane Ian, which lashed Florida and the Carolinas in late September, "had no discernible effect on the national employment and unemployment data for October."

The Fed on Wednesday delivered another 75 basis point interest rate hike and said its fight against inflation would require borrowing costs to rise further. But the U.S. central bank signaled it may be nearing an inflection point in what has become the fastest tightening of monetary policy in 40 years.

Last month's broad-based increase in hiring was led by healthcare, which added 53,000 jobs. Professional and technical services payrolls rose by 43,000 jobs.

Employment in manufacturing rose by 32,000 jobs, while leisure and hospitality added 35,000 positions. Leisure and hospitality employment remains 1.1 million jobs below its pre-pandemic level. The sector has the most job openings.

Government payrolls rebounded by 28,000 jobs. There were moderate employment gains in the interest-rate sensitive sectors like financial activities and retail trade. Construction payrolls barely rose, while transportation and warehousing added 8,000 jobs.

The "birth-death" model, which the government uses to estimate how many companies were created or destroyed, showed a jump in new business creation estimates, which some economists said could have artificially boosted payrolls.

The birth-death add-factor to the non-seasonally adjusted level of payrolls was 455,000, exceeding the previous October-high of 363,000 in 2021.

"This is well-above the 18-year average of 140,000," said Sarah House, a senior economist at Wells Fargo in Charlotte, North Carolina. "Technical factors related to the birth-death model appear to be flattering the nonfarm payroll numbers."

Others were, however, were skeptical, noting that the large birth-death factor followed a 172,000 drop in September.

Stocks on Wall Street were narrowly mixed. The dollar fell against a basket of currencies. U.S. Treasury prices were mixed.


Job growth has persisted as companies replace workers who have left. But with recession risks mounting because of higher borrowing costs, this practise could end soon. A survey from the Institute for Supply Management on Thursday found some services industry companies "are holding off on backfilling open positions," because of uncertain economic conditions.

Average hourly earnings increased 0.4% after rising 0.3% in September. Wages climbed 4.7% year-on-year, the smallest gain since August 2021, after advancing 5.0% in September as last year's large increases fell out of the calculation.

Other wage measures have also come off the boil, which bodes well for the inflation outlook. Inflation data next week is expected to show the annual increase in consumer prices slowing to below 8% for the first time this year.

But with inflation shifting to services, the battle against higher prices will be a long one.

Details of the household survey from which the unemployment rate is derived were soft. The increase in the unemployment rate from 3.5% September reflected a 328,000 decline in household employment. The ranks of the unemployed increased 306,000.

"While there is slowing in the pace of labor market activity, that slowing has been much too gradual and today's report leaves the Fed on track to hike at least 50 basis points at next month's meeting," said Michael Feroli, chief U.S. economist at JPMorgan in New York.

About 22,000 people dropped out of the labor force, pushing the participation rate, or the proportion of working-age Americans who have a job or are looking for one, to 62.2% from 62.3% in September.

There was also an increase in the number of people unemployed for 27 weeks and more. But the number of people working part-time for economic reasons fell.

The employment-to-population ratio for workers in the 25-54 age group dropped 0.4 percentage points to 79.8%. The decline was the largest since April 2020.

The rate at which unemployed people are finding jobs slowed to 26.7% from 28.6% in September.

"There's some very clear signs of slowdown, and that could be a moderation, but depending on a variety of factors that moderation can turn into a deterioration," said Nick Bunker, head of economic research at the Indeed Hiring Lab. "The hope is that the labor market is merely returning to a more normal pace, rather than sitting dead in the water."

Some more food for thought on the US jobs data:

There is little doubt in my mind that US employment is slowing and will continue to slow significantly over the next 12 months. Just look at what is going on in the housing sector:

This is why I agree with those who think the Fed's forecast for unemployment to hit 4.4% in 2023 is ridiculous, it will be double that rate:

Importantly, and I want to be crystal clear here, anyone who still thinks the Fed can engineer a soft landing next year deserves to have their head handed to them.

In fact, after watching Powell's presser on Wednesday afternoon, I'm beginning to believe that the Fed is ready to err on the upside just as it was ready to err on the downside when the pandemic hit.

And slower rate hikes in December and afterward should not be interpreted as a "pivot", just that the terminal rate is moving up and the Fed has "ways to go" as Powell clearly stated a few times during his presser.

Fed officials are coming out again to speak publicly but the message remains the same one we heard after Jackson Hole, the Fed remains focused on bringing inflation down and will do whatever it takes to do this:

I think Powell and company are very much worried about what happens if inflation becomes entrenched, learning from the mistakes made during the Volcker era:

The big risk is that the Fed does pause sometime next year for 6 months or longer and wage inflation starts creeping up.

Then what happens? 

As far as stocks, there was a lot of hope that the Fed was ready to pivot this week when the FOMC statement was released and a little new insert was added (probably to appease the doves):

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.

Some people wrongly interpreted this as a dovish statement but Powell went all Jackson Hole on them during his presser after the statement was released:

And that ruined any chance of a stock market party on Wednesday afternoon as gains quickly reversed into losses:

Of course, I was waiting for it:

It never ceases to amaze me how stock traders think they can front-run the Fed without realizing their actions will bring about a worse drop later on as they keep anticipating a pivot:

More importantly, while the FANGMAN stocks got clobbered again this week, the market has yet to price in an earnings recession:

Of course, if the US and global economy are slowing, those Big Tech stocks will get bid which is what happened Friday but they remain very weak:

Not surprisingly, the Nasdaq remains weak while the Dow looks toppish here even if some stocks like JPMorgan have ran up nicely in the last three weeks and look good here:

Any time I see a big bank stock rally 30% in a few weeks in this environment, I get nervous. 

There is so much herding going on, you have to wonder what happens when hedge funds pull the plug. 

Speaking of hedge funds, another billionaire is worried that the end of the world as we know it is approaching:

Time to buy some protection? Oh, wait, that's not working out well so far this year:

You have to wonder if this market is being manipulated and when something breaks, vol will explode higher:

Anyway, next week after midterm elections we get US CPI for October (Thursday morning) and it should begin to show some moderation given used car prices and M2 money growth have fallen off a cliff, but I'm not betting on it.

Speaking of used car prices, Carvana (CVNA), Roku (ROKU) and Twilio (TWLO) are this week's examples of stocks NOT to buy just because they are down huge from their peak:

There are a lot of young traders who think all you need to do is buy big dips and sell the rips.

Not in this market, we are just beginning a long bear market and 9 times out of 10, you'll get your head handed to you doing things that worked in early 2021. 

In bear markets, it's not about return on capital, it's about return of capital. 

It literally feels like Chinese water torture and I'm afraid to say we haven't felt the brunt of it yet. 

The most important chart you need to pay attention to is this one on high yield bonds:

If that breaks down further, we're in big trouble.

As far as bonds, the bond market is very aware of what the Fed said this week:

If I am right and the Fed is willing to err on the upside in its rate hikes, then long bonds will start rallying strongly as we approach that last Fed rate hike (whenever that is).

For now, US long bonds remain weak but they look like they're bottoming here:

It's a tough call because if the Fed pauses and wage inflation starts picking up, long bonds will get hit again.

Lastly, I remain long on the greenback and think every dip should be bought:

I know it has rallied like crazy but there are plenty of reasons to stay long for now, the Fed being just one of them.

Alright, let me wrap it up there and remind people reading this blog regularly that you can support the work via PayPal on the top left-hand side under my picture. I thank all of you who value the work and support my efforts.

Below, watch the FOMC press conference from Wednesday afternoon and pay close attention to when Powell says this:

"At some point, it will become appropriate to slow the pace of increases as we approach the level of interest rates which will be sufficiently restrictive to bring inflation down to our 2% goal. There is significant uncertainty around that level of interest rates. Even so, we have some ways to go and incoming data from our last meeting suggest the ultimate level of interest rates will be higher than previously expected."

Next, Frederic Mishkin, former Federal Reserve Board Governor, joined 'Power Lunch' right before the rate decision to discuss market reaction to increases in the Federal funds rate and the projected timeline for curtailing inflation.

In my opinion, Mishkin is absolutely spot on and he understands monetary economics better than most people. Listen to what he says about the likelihood of a soft landing and why the Fed needs to keep at it, explaining mistakes Volcker did back in the early 80s.

Third, Nela Richardson, ADP chief economist, Liz Young, head of investment strategy at SoFi, Jason Furman, professor at the Harvard Kennedy School of Government and former CEA chair, Michael Strain, American Enterprise Institute, and CNBC's Steve Liesman and Rick Santelli join 'Squawk Box' to react to October's stronger-than-expected jobs report.

Fourth, CNBC’s ‘Halftime Report’ investment committee, Bryn Talkington, Shannon Saccocia, Jason Snipe, Steve Weiss and JPMorgan's Dubravko Lakos discuss the Fed and market outlook after today's jobs report.

Fifth, "high-quality munis and Treasuries are actually starting to look very compelling here," Joe Davis, Vanguard's global chief economist and head of investment strategy, says during an interview on "Bloomberg Markets: The Close." 

Lastly, and very importantly, the Macro Specialist Designation (M²SD) from Francois Trahan of Trahan Macro Research is a study program designed to help financial professionals understand how macro trends impact equity markets and how to successfully implement macro techniques in their investment analysis. 

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It’s also worth noting Francois joined Twitter recently and you can follow him here (@FrancoisTrahan).

Oh, and make sure you read Francois's latest weekly comment, The Death Spiral In Housing ... And What It Means For Stocks. He's also holding a conference call this Thursday morning at 10:30 am on why it's still not too late to join the bear market rally.