Jobs Report Is First Big Test After Federal Reserve Lets Loose The S&P 500

The January jobs report will be the first big test of the S&P 500 rally sparked by Fed Chair Jerome Powell's comments.

Federal Reserve chair Jerome Powell launched the S&P 500 index on Wednesday. However, a continuation of the rally will depend if economic data support the bull case. The January jobs report will be released at 8:30 am ET on Friday. The first test will be whether inflation and wage growth moderate sufficiently to convince the Fed that it can pause rate increases in March.

Wall Street economists anticipate that the Labor Department will release its jobs report on Friday, and they expect to see a decline in payrolls from December's 223,000 to 185,000. The average hourly earnings is expected to increase by 0.3% in the next month. This will lower the 12-month growth to 4.4%, from 4.6%. The unemployment rate is expected to rise from 3.5%, which is the lowest rate in over a half century, to 3.6%.

If the forecasts for the jobs report are accurate, then there should be more room for growth in this current stock market rally. What could stall the S&P 500? The Fed might be concerned about another month of low unemployment, but a wage increase that is higher than expected would raise a red flag.

The S&P 500 rallied this week was sparked by the Employment Cost Index, which showed that total pay growth had slowed down to 1%. This marked a three-quarter deceleration since a high of 1.4% during the first quarter of last year. The private sector compensation costs increased by 0.9% or 3.6% annually, excluding incentive-paid occupations where the volatility of sales commissions can cloud the picture.

This is just a little bit above the 3.5% wage increase that Powell said would be consistent the Fed's target of 2% inflation.

Powell's Wednesday press conference highlighted the importance the Q1 ECI Report, which is due the week before the crucial May 2-3 Fed Meeting.

A positive surprise in wage growth for January wouldn't necessarily be the end of this S&P 500 rally because it is only one month. However, it could dampen animal spirits.

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Vanguard's senior economist Andrew Patterson stated in a note published on Thursday that he is predicting a "resurgence in wage growth" in Q1. He cited a still high level of resignations as people continue to seek better-paying jobs, along with "structural labor issues."

According to the Labor Department's Job Openings and Labor Turnover Survey, 4.1 million workers quit in December. This is equal to 2,7% of all employees. This is about 15% more than the range of 2.3%-2.4% that was prevalent before the pandemic.

ADP, a payroll processor, reported on Wednesday that the pay growth of job changers increased to 15.4% for January. Pay growth for job-stayers was flat, at 7.3%.

Some economists expect a job growth of up to 300,000 in January. Investors may not be concerned about a large headline job gain. This is partly because the January job reports have large seasonal adjustments. Employers in retail, warehouses and temp services hired fewer seasonal employees in Q4. In Q4, employers in the retail, warehousing and temp services sectors hired fewer seasonal workers.

The annual adjustment by the Labor Department for population growth is also included in the January jobs report. Some economists predict that Friday's report will show a higher labor force contribution in 2022 due to increased immigration. Although immigration is a controversial issue, it can lead to more slack on the labor market. This could ease wage pressures.

In the Fed's Wednesday policy statement, policymakers noted that they expect "continuous increases" to the Fed's main interest rate. Powell's speech was hardly bullish but the S&P 500 soared after his appearance. Wall Street was swayed by Powell's optimism about the economy and his lack concern over the recent big S&P 500 rallies and the drop in Treasury yields.

The minutes of the December Fed meeting expressed concern that easing financial conditions might make it more difficult to control inflation. Powell seems to be ok with rising stock prices and lower interest rates because "the market expects inflation to move down faster."

Fed policymakers expect inflation to decline more slowly, pushing rate cuts into 2024. Powell did not rule out a 2023 rate cut, "if inflation does come down much faster."

The Fed is no longer in a panic because inflation and wage growth are at levels which have slowed down. Powell is no longer concerned about what happens to the S&P 500 from week-to-week. This is great news, as long as the inflation rate continues to moderate. The S&P 500 could still go too high if data disappoints.

The S&P 500 gained about 1% in Thursday's stock market activity, adding to the 1.05% increase on Wednesday. By Wednesday's closing, the S&P 500 was up 15.2% from its bear-market low of Oct. 12, but still 14.1% off its all-time high.

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