As the year comes to a close, it seems that the market's focus on inflation rates are shifting to a new area of concern: Unemployment. While the Federal Reserve has taken steps to fight inflation by curbing economic growth, the full extent of the damage to the employment market is yet to be seen.
What's happening: Low unemployment rates and wage growth may appear to be good for an economy that's close to recession, but has actually proven bad for markets.
Stocks plunged earlier this month after the closely watched November jobs report showed a resilient labor market. They fell again on Thursday when weekly numbers showed the number of Americans filing for unemployment benefits fell, indicating a still-tight labor market.
That's because in this good-is-bad economy, inflation and unemployment have an opposite relationship — higher wages mean higher inflation as companies pass on higher costs by raising the price of goods. Investors worry that a strong jobs report could fuel Fed officials to accelerate their rate increase campaign.
At the same time, if jobs fall precipitously, the economy could plunge into a deep recession — that's not a boon for markets either.
Investors are hoping for a Goldilocks situation where unemployment falls just enough to convince the Fed that its rate hikes have cooled the labor market enough to end hikes but not enough to cripple the economy. That's a very narrow path to land on.
What the Fed wants: The Federal Reserve released its economic forecast on Wednesday, predicting that the rate of unemployment would increase to 4.6% by the end of next year, up from 3.7% today. The unemployment rate has never risen that much outside of a recession and those numbers mean about 2 million Americans would have to lose their jobs (or enter the workforce-- which is exceedingly unlikely).
Fed Chair Jerome Powell did not mince words last week when he said that the strong job market is exceedingly responsible for inflation and will have to weaken before rate hikes end. "There's an imbalance in the labor market between supply and demand," he said, adding that it will take a "substantial period" to fix that imbalance.
"Without price stability, the economy doesn't work for anyone," Powell said Wednesday.
That path to the Fed's 2% inflation target is through the jobs market. "There will be some softening in labor market conditions," Powell said. "And I wish there were a completely painless way to restore price stability. There isn't. And this is the best we can do."
What might happen: "Boy the Fed is really committed to this put us in a high unemployment recession thing," Jon Stewart, former host of The Daily Show, tweeted after Wednesday's meeting.
It's possible that he's correct — but some economists still think there's hope that if employment softens in the first half of next year a Fed pivot could come quickly and with it, recovery.
"Employment has yet to soften notably, but I think the jobs data is likely to deteriorate meaningfully and quickly," said finance professor Jeremy Siegel of The Wharton School of the University of Pennsylvania in his weekly commentary for WisdomTree last week.
Powell expressed optimism on Wednesday that a soft landing was still possible and that the labor market was tight enough to withstand an increase in unemployment without snowballing into a recession. Investors, meanwhile, will be watching jobs numbers very closely.
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