January jobs report a ‘meaningful gut check’ for markets: Economist

New York Life Investments Economist and Portfolio Strategist Lauren Goodwin and RSM Chief Economist Joe Brusuelas join Yahoo Finance Live to discuss the January jobs report, the expectations for the Fed following Wednesday’s FOMC meeting, a possible recession, and the outlook for the labor market.

Video Transcript

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- All right, let's get a deeper dive into the report. New York Life Investments economist and portfolio strategist, Lauren Goodwin, is with us, and RSM Chief Economist, Joe Brusuelas. Whoa, guys. So Joe, I have to say you were flagging going into the report that you had seen some estimates that were starting to move up in dramatic fashion. But not this dramatic of a fashion. What the heck?

- OK, let's all take a step back and breathe. January has lots of seasonal noise attached to it. This report, however strong, exaggerates the true underlying pace of hiring in the economy. OK, once you start to unpack this, what you're seeing is, OK, wage growth is high, but it's decelerating.

OK, second, everybody out there in the market got on the wrong side of the Fed this week. This jobs report, if you really want to watch the impact on the market look at the two-year yield. Before probably 30 minutes pass, we'll go full round trip back where we were before Powell's press conference started.

All right, second, hiring is still strong. It's too strong. We need to generate some labor slack in this economy to ensure that we get back to 2% inflation at one point late next year or 2025. Finally, too many people are going to conflate this today, and they're going to overreact. And I just think it's really important here-- we get all kinds of noise every January. Every once in a while, you get one of these big outliers. I would take this with a grain of salt, focus on the underlying trend, and proceed accordingly.

- Well Lauren, doesn't this raise-- just push back on this notion that, I think, the market priced in this week, that we will get a Fed pivot? This is a very strong report.

LAUREN GOODWIN: It is a very strong report. I think actually that the market's been on the wrong side of the Fed for a year. It's been time after time after time that the Fed has been, frankly, pretty consistent, especially in the last six months with its messaging on where the terminal rate is going, what they expect they'll need to do in order to bring inflation under control, and the importance of bringing inflation under control for the average household.

This week was no exception. And so I agree with what Joe's saying in that the underlying trend hasn't changed a whole lot, and the cyclical rally that we've been seeing over the past couple of months, especially in January, that's been fueled by hopes for a Fed pause, as well as some international growth risks moving off the table, this is a meaningful gut check, and on at least one of those factors.

- If your Fed Chair Jay Powell waking up this morning, you see this print, you're putting on your slippers, what do you think to yourself about that terminal rate at the end of the day?

JOE BRUSUELAS: Well, I think the terminal rates going above 5% is what I think. The Fed pretty much told us they were going to raise rates three more times at the December forecast, right? They hiked it by 25 basis points this week. They're going to do it again in March, and they're going to do it again in May.

Then maybe, maybe we can take time for a strategic pause to let the economy continue to absorb those six super-sized rate hikes that happened last year. I got to tell you guys, the market is wrong all of the time. The market's really out of alignment here this. Actually I think is probably a good thing for the market over the medium term, but today may be a bit painful.

- Well listen, the market's out of alignment because Jay Powell put it out of alignment. And so, I mean, you could say, Lauren, that he was sort of clumsy at the press conference if indeed-- he was asked several times are you concerned about loosening financial conditions, and he didn't really come out and say yes I am, which is what he had done in the past that slapped the markets down. Why do you think he wasn't more aggressive there?

LAUREN GOODWIN: To be honest, I think it's just because we are getting close to the point that the Fed has identified where it'll be a good idea to sit and stop and let these long and variable lags take their effect. So again, for months now the Fed has been saying that a 5 to 5.25 terminal rate target range is likely to be appropriate. And, as Joe pointed out, that's a couple hikes away.

It's fairly typical-- even as atypical as this economic cycle has been-- it's fairly typical that the labor market would be the absolute last domino to fall in the trajectory of an economic cycle. We actually were running some data and saw-- surprised me actually that 9 of 10 of the last recession-- 9 out of the last 10 recessions employment was still growing when the recession began.

And so this is not actually so unusual. And so for Powell to say, hey, we're going to hike two more times 25 basis points each, and then it makes sense to sort of sit and let things play out, that's a reasonable approach. I agree it could have been more direct about that, but the market was likely to take that as dovish, no matter which way he says.

- Sometimes it hears what it wants to hear. That's true.

- Part of the surprise here, I think, is that for the past couple of months all we've been hearing is about layoff announcements, notably in big tech. Why did they not show up here and when do they start showing up?

JOE BRUSUELAS: OK, they're not. There's a couple of things going on here. First, the meeting duration of unemployment going into this report was eight weeks. I haven't had a chance to see the report. People in tech have skill sets that are in demand across the entire economy.

So I live in Austin. A kid who makes $275,000. She's 27 years old. She works at Twitter. If she gets laid off, she'll find a job like that. It won't pay $275,000. It'll pay probably close to $200,000, right? They're getting jobs. Moreover, they get long severance packages. Some of them are doing contract work. These people, I mean, they--

- But even-- I mean, as we've talked about, even most of, many, if not most of the companies that are laying off are also still hiring.

JOE BRUSUELAS: That's right. Yeah. Yeah. I mean, you're getting just a rightsizing of the workforce. In labor, there is labor-hoarding because those people are impossible to get. I mean, these people are really in demand across the real economy. And I want to come back to something here.

Powell has a remit to make policy for the real economy, not for financial markets. And everybody needs to understand that when we've had a historic inflation impulse, had a 20-month peak, and we're now seeing some disinflation that's mostly correction in the supply chain, not disinflation because the economy's going to have a real long term problem, yeah, I understand whether some misalignment.

But he needs to continue down this path. Financial conditions are still roughly 1.5 to 2 standard deviations below neutral. That means it's a drag on the economy. It's not as bad as it was six months ago, right? So everybody gets on TV and says, well, financial conditions improve. OK. No they have not. They are tight and they need to remain there. So we can restore price stability because price stability is what counts in the real economy.

- For consumers that, yes, many of them who are working and are looking for that price stability as well, at the same time as they're looking to, perhaps, outpace some of where the prices have risen to at this point in time before those prices, perhaps, start to retreat or normalize once again. You know, what within the wage front here that we're seeing within this report gives them confidence that they can see wages stabilize for an extended period of time in order to weather what is still an inflationary-- or at least disinflationary starting environment?

LAUREN GOODWIN: Not a whole lot, to be honest. Real wages have been declining since April of 2021. That's why this has been already such a challenging environment for so many families. Actually, the number one question when I'm speaking with clients that I get when we start talking about recession is aren't we in recession already? That's how it feels.

And that is why some of the conversation and, frankly, the market movement around a soft landing I think could be misplaced. I'm not convinced that a soft economic landing under these conditions is what makes the best economic outcome for most people because recessions, though painful, provide a really important service, which is to reduce or eliminate imbalances. Typically in the last couple of cycles, it's been some sort of leverage.

Household leverage. Corporate leverage. In this cycle, it's inflation. And that's why Powell is out there saying, including in this week's press conference, unless we are able to bring inflation under control, the economy works for no one. And so wage growth here persistent. That's good news, but not if it's continuing to fuel companies' need to raise prices higher.

JOE BRUSUELAS: So look, we're just turning the corner on real wages. They're just moving into positive terrain. Consumers after that 20-month shock are just getting a chance to breathe and get ahead. I just looked at the unemployment rate out to three digits. It's 3.434%. That's lower than anybody's lifetime who's in this room right now. I mean, this is extraordinary stuff that's happening.

- I want to circle back to the beginning when we were talking about January.

JOE BRUSUELAS: Yeah.

- Because I want to do a little impromptu Yahoo U. Just break it down for us in simplest terms. Why is January weird and, like, they changed the denominator in January. Talk to me. What's happening?

JOE BRUSUELAS: It's real simple. People quit jobs. Hiring gets reset. Wages get reset. It's very difficult to estimate.

- Every January?

JOE BRUSUELAS: Every January. So the seasonals are really, really important here, which is why, yeah, the labor markets do strong, but it's not that strong, right? What I'm really more interested in is that labor force participation rate. The 3.4% unemployment rate. And hey guys, look at the household. Remember a couple of months ago all the sharks in the market were like this isn't true, look at the household. We almost had 900,000 increase in the household employment. That's statistically significant, and that's huge.

- Lauren, what do we do with all of this information? What action do we take from here for the people who are looking ahead at 2023 and they want to make money and hopefully make back some of the money they lost last year?

LAUREN GOODWIN: Well look, I think that this is likely to put a tactical hit on what has been otherwise a risk on cyclical rally. Again, not only because the market is getting a line of sight on the Fed's terminal rate, but also because we've seen some important global risks at least pause for now, including the energy environment in Europe, China's economic reopening, etc.

For investors, that can be really tactical. Yeah, the next couple of days are likely to be a little choppy after this data, but some of those positives for the economy still stand. Most investors aren't able to be so tactical. And the way that the economic evidence is stacking, it's very clear that we are going to see slowing economic growth and continuing deterioration in margins over the course of this year.

So we're actually leveraging the strength in markets recently as an opportunity to rebalance towards things that are a little more durable, focused on income generating in the market, and just an acknowledgment that as certain as Joe and I and anybody can come up here and sound, this is an economy with a large confidence interval. It's just such an uncertain environment. And so, why leave up to chance in market timing what you can generate in a portfolio via income and a little more durability?

- Joe, what do you think we might hear from various Fed officials in coming weeks when they hit that speaking circuit?

JOE BRUSUELAS: Oh, you're going to hear them reinforce what Powell attempted to put forward, which is the rates are going to increase. We may take a pause at one point, but that doesn't mean we're necessarily finished. They need to finish the job here, Brian. I mean, if they're going to get-- they're going to reestablish price stability, they absolutely have to err on the side of caution, even if that means the Fed causes a downturn in the economy for a brief period of time. It's quite mild.

- And Lauren, it looked like you wanted to add something after that, and I just want to add this on to it. If you're looking at this print, what is the first trade that you make after you read this report?

LAUREN GOODWIN: Well, the first thing that I-- the thing I was going to add to what Joe is saying is that as you were discussing earlier, this might appear that this job report makes the Fed's job harder. I think it actually makes their messaging a lot easier, a lot more straightforward. It makes the market's job harder.

And so, again, if you're able to be incredibly tactical today, this is a moment for, again, a cycle back into the improvement in value equity over growth, in investment grade credit over high yield, et cetera. But tactical isn't for everybody, so the medium long term focus we think makes sense.

- I think all of our jobs just got a lot harder today. That much I'm sure.

[LAUGHTER]

New York Life Investments economist and portfolio strategist, Lauren Goodwin, and RSM Chief Economist, Joe Brusuelas, good to see you both. Thanks so much for the insight. Tremendous.

JOE BRUSUELAS: Thank you.