The 10-year US Treasury yield closed 2 basis points lower at 3.49%—having jumped as much as 12bps earlier in the session—while the 2-year yield rose 5bps to 4.28%. Futures market pricing for the expected peak in fed funds next May increased by 6bps to 4.92%. The DXY dollar index, which had risen in the wake of the jobs data, closed 0.2% lower.
The US labor report showed that non-farm payrolls grew by 263,000 in November, the slowest job growth since April 2021 but well above expectations for an increase of 200,000. The unemployment rate was unchanged at 3.7%, slightly above a 50-year low. Average hourly earnings rose 0.6% month-over-month, the fastest pace since January, and October’s figure was revised up from 0.4% to 0.5%.
What do we expect?
Friday’s market swings capped a volatile week for the S&P 500, which had rallied more than 3% on Wednesday as Fed Chair Jerome Powell signaled a likely downshift in the pace of rate hikes after four consecutive 75-basis-point increases.
Several data releases during the week pointed to a weakening economy and an easing of inflation pressures. The ISM Manufacturing PMI fell into contraction territory at 49 in November, down from 50.2 in October and the lowest reading since May 2020. The prices paid component of the index declined for an eighth straight month. Meanwhile, the US core personal consumption expenditures (PCE) price index, the Fed’s preferred measure of inflation, increased by 0.2% month-over-month in October, a moderation from September’s 0.5%.
But we think Friday’s jobs report indicated that the labor market remains tight. In particular, the 0.6% growth in average hourly earnings, after 0.5% in October and 0.4% in September, is too high for the Fed’s liking and heading in the wrong direction. The declining labor force participation rate—which ticked down to 62.1%—is also discouraging, in our view.
As Powell said in his speech at the Brookings Institution, wage growth remains “well above the levels that would be consistent with 2% inflation over time.” He noted the risk of this spilling over into core services inflation, making it harder to bring down.
We appear to be heading for a situation where inflation is slowing from its peak, but is not on track to hit the 2% target because of rapid wage growth. We think this could eventually end up forcing the Fed to raise rates beyond the 5% terminal rate currently priced into markets. However, we still expect the Fed to moderate the pace of hikes to 50bps at the FOMC meeting on 14 December.
Economic growth is likely to slow further next year as the cumulative impact of Fed rate hikes weighs on activity, in our view. This should take a toll on corporate earnings. We expect 2023 S&P 500 EPS to contract by 4%, and believe bottom-up consensus expectations for 5% growth may be too optimistic.
How do we invest?
Markets are likely to remain volatile, and we do not think the economic conditions for a sustained upturn are yet in place. But given the prospect of periodic rallies, we prefer strategies that add downside protection while retaining upside exposure.
We prefer the more defensive areas of the equity market—including consumer staples, healthcare, and quality-income stocks—which should be relatively resilient as economic growth deteriorates. We also favor value stocks, which have historically outperformed when inflation is above 3%. In fixed income, we prefer higher-quality and investment grade bonds versus high yield.
The US dollar has fallen by around 8% from its peak, but we expect renewed strength for the safe-haven greenback in the months ahead as the slowing global growth environment#particularly in Europe#comes back into focus. We also like the Swiss franc, and hold a least preferred view on the euro and sterling.
Meanwhile, high equity-bond correlations this year have underlined the importance of seeking alternative sources of return, for example in certain hedge fund strategies. Macro strategies have been particularly strong performers this year, and we expect them to continue to do well in volatile markets.
Main contributors - Mark Haefele, Brian Rose, Alison Parums, Vincent Heaney, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Strong US jobs report prompts market swings, 5 December 2022.