The Golden Path

Stocks bounced this morning, reversing a two-day decline. Currently, the Dow is up 98 points and the S&P 500 is up .6%. Bonds, which sold off hard earlier in the week, are also in rally mode as interest rates edge lower.

The Bureau of Labor Statistics (BLS) just published its monthly Employment Situation Report and the numbers are much weaker than yesterday’s report from ADP. Whereas ADP tallied US private sector payroll gains at about 500,000 during June, BLS says it was closer to 150,000. What’s more, BLS reduced its prior month tally to 259,000 from the initial estimate of 283,000. So it seems that hiring activity is finally slowing in the face of rising interest rates. And yet, some of the other numbers remain strong. The average work week ticked up to 34.4 hours, average hourly earnings growth held steady at 4.4%, and the unemployment rate fell back to 3.6%.

Wall Street’s reaction to this report isn’t what you’d assume. Believe it or not, this sign of slower hiring actually halted the two-day stock market decline. Why? Economic data over the past week had been so strong that traders began to worry that maybe the Fed hadn’t done enough to bring inflation under control. The fear of reaccelerated interest rate hikes became palpable. So this softer jobs report moderated some of that fear.

CNBC interviewed Chicago Federal Reserve Bank President Austan Goolsbee this morning. He agrees that inflation needs to come down more, and he foresees one or two more small interest rate increases through the rest of the year. But he doesn’t expect an imminent recession, and doesn’t believe we need a recession in order to break inflation. Bringing the economy back into balance without triggering a downturn is what he calls the “golden path,” and “I feel like we’re on that golden path.“

In my view, investors have been obsessing to an unhealthy degree about the path of inflation, fretting endlessly about stubbornly high prices specifically within the services sector, which are still rising more than double the Fed’s 2% target. And it is true that Fed Chair Jerome Powell has fed into this anxiety. But Mr. Goolsbee has a very different view, which runs contrary to the current market narrative. He said the “main reason why inflation has been more persistent than we anticipated is that goods inflation hasn’t yet come down as much as we thought.” So the problem isn’t services, which he has expected to remain stubbornly high. He said that prior to Covid, overall inflation was about 2%, with services much higher than 2%, goods at about zero, and housing at about 4-5%. So why would we expect services inflation to fall to 2% now? And since it’s fairly clear that both housing and goods inflation are moderating, it’s reasonable to expect that we are on the “golden path.”