A Better-Than-Expected Jobs Report Causes Markets To Plummet: Here’s Why

Topline

Stocks tumbled Friday as investors reacted to data revealing a stronger-than-expected labor market, demonstrating the head-scratching but fundamental economic concept that many see lower unemployment and higher wages as a bad omen for the market.

Stocks historically fall as interest rates rise.

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Key Facts

The Dow Jones Industrial Average fell 630 points, or 2.1%, while the S&P 500 and tech-heavy Nasdaq tumbled 2.8% and 3.8%, respectively.

The dip followed the release of the Labor Department’s hotly anticipated monthly jobs report, revealing that the country added 263,00 jobs, higher than economist estimates, and the unemployment rate fell from 3.7% to 3.5%, lower than estimates.

Jeffrey Roach, LPL Financial’s chief economist, said in a statement that the “decline in the unemployment rate will likely frustrate the Fed as tight labor markets could drive up wages,” alluding to the Federal Reserve’s ongoing fight to combat the worst inflation in four decades by further raising interest rates, a major driver behind stocks’ dreadful 2022 performance.

There is a strong historic inverse relationship between unemployment rates and inflation, demonstrated by the Phillips curve familiar to Economics 101 students, a concept that Fed chair Jerome Powell said in 2018 “continues to be meaningful for monetary policy.”

Powell remains steadfast in his belief that a weaker labor market is necessary to bring down inflation despite recent criticism of the concept, saying in August that the labor market is “clearly out of balance.”

Stocks typically fall alongside rate hikes as corporate earnings suffer because companies become less willing to borrow money at higher interest rates.

Big Number

6%. That’s how high unemployment needs to be to tame inflation, Clinton-era Treasury Secretary Larry Summers said Thursday, a more than 70% increase from its current rate.

Key Background

Inflation is currently over 8%, far past the Fed’s 2% target, and the central bank has hiked the federal funds rate five times since March to its highest level since 2008. The market has tanked as rates have surged, with the Dow down 20% year-to-date, on pace for its worst year since the Great Recession. Numerous major companies have conducted layoffs in recent months, most citing poor macroeconomic conditions, including JPMorgan Chase, Goldman Sachs and Snap.

Contra

Andrew Challenger of the career services firm Challenger, Gray & Christmas said Thursday that the labor market is beginning to show “some cracks,” after his firm reported a massive increase in job cuts and hiring intentions.

Tangent

The Fed is relatively powerless in actually affecting the labor market, instead banking on the trickle-down effect of rate hikes leading to slumping corporate profits due to the higher borrowing costs, which also dampen consumer demand. Some criticize the Fed’s hope for higher unemployment as cruel and misguided, including Sen. Elizabeth Warren (D-Mass.), who wrote in a June Wall Street Journal op-ed: “Make no mistake: If the Fed cuts too much or too abruptly, the resulting recession will leave millions of people—disproportionately lower-wage workers and workers of color—with smaller paychecks or no paycheck at all.”