Economists Sound the Alarm: Interest Rates in the US Could Soar Above 5%

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•  Feb 06 2023
 

The published employment report surprised the markets and the economists, whose predictions were far from the actual data. Nor will the Federal Reserve take the economic strength of the American labor market lightly. Economists warn: "The chance of sharper or longer interest rate hikes is increasing.

The markets reacted to the report with declines since the data indicate economic strength - which will not be received lightly by senior Fed officials, who want to see a weakening that will prevent high wage increases and pressure on inflation. The 517,000 new jobs reported are twice the most aggressive expectations, which illustrates the magnitude of the surprise. Also, the unemployment rate dropped from 3.5% to 3.4%. This is an impressive achievement, since at the same time the rate of participation in the civilian labor force has increased, which shows both optimism in finding a job and actual absorption by employers. Finally, the hourly wage registered an annual increase of 4.4%. Although this is a slowdown, the previous figure has been revised upwards from 4.6% to 4.9%.

It wasn't just the employment report that worried the markets. Apart from the employment data, the Purchasing Managers' Index for non-industrial companies also recorded a much stronger expansion than market expectations. The input prices section of the index is also at a high level and does not herald a slowdown any time soon, following the data there are question marks as to whether the US economy will go into contraction. As a result, the chance of sharper/longer interest rate hikes increases. It will inevitably be the last and the interest rate may end up above 5%. At the same time, the consumer price indices for the months of January and February will be published before the next interest rate announcement and the results could significantly influence the next interest rate decision.

The Missing Piece in Employment Data Compared to the Economy

Most of the increase in jobs was recorded in the hospitality and leisure industries (128 thousand) and education and health (105 thousand). The branches of professional services (82 thousand), government (74 thousand) and retail (30.1 thousand) also stood out, where the increase in government jobs is mainly the result of the end of a strike that was in the universities. In industry 19 thousand jobs were added, finance about 6 thousand jobs and in the technology branches the number of jobs decreased by 5 thousand.

The labor market data continues to be strong and this is in complete contrast to all the other data we receive from the American economy - consumer and business confidence is at low levels (even after a slight increase in recent months), the purchasing managers' indices signal a contraction in economic activity and the GDP data show a decrease in investments and a significant slowdown in private consumption. Beyond that, activity in the real estate market is shrinking rapidly with a drop in sales, construction starts in prices. And after all this, the job market still continues to be very strong.

How the Unemployment Report Impacts Bond Yields

The data of the last period, in particular those that refer to the labor market, prove that the confidence demonstrated by the markets, especially the bond market, does not have a solid basis. "Labor markets in all countries continue to be very strong. The number of vacancies in the main countries is still significantly higher than it was before the corona virus and the unemployment rate does not increase in almost any developed country. We received proof of the strength of the labor markets in the US with more than 500,000 new jobs and a drop in unemployment to 3.4% in January. These data, combined with an increase in vacancies and a very low number of unemployment benefit claims, leave no doubt that the state of the labor market in the US still very strong.

The main thing that distinguishes the current labor market is the unusual increase in jobs in the service industries, adds Zabrzynski, and specifies that the American economy created almost 4 million jobs in the service industries in the last year - about 60% higher than the maximum rate in the decade before Corona. On the other hand, the number of jobs created in the industrial and construction sectors (about 700 thousand) is only about 6% higher than the pre-pandemic maximum, a situation he says is very different from the recovery from the crises in 2008 and 2000. "An increase in the demand for services is expected to continue because their consumption has not yet returned to the trend that existed before the corona virus. As a result, the service industries, which are labor-intensive, are expected to continue to hire many workers, despite the slowdown in growth.

So What's Next?

The employment report is expected to weigh on the bond and stock markets in the near future, because the pressure on yields will be upward, which will also take the wind out of the sails in the stock markets.

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Please note that the article should not be considered as investment advice or marketing, and it does not take into account the personal data and requirements of any individual. It is not a substitute for the reader's own judgment, and it should not be considered as advice or recommendation for buying or selling any securities or financial products.

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