Daily Update: As Good As It Gets?

Every month, we get a fresh reading on the heart of the U.S. economy: the job market, which pumps dollars into the households that one way or another drive 70% of all domestic spending.

Today’s numbers were about as good as it gets. Another 431,000 people went back to work, bringing the broad unemployment rate down to 3.6%.

From all empirical evidence, the economy is moving in the opposite direction of a recession, which usually starts with mass layoffs and a fresh cycle of unemployment benefit claims. This is somewhere between recovery and full-fledged boom.

But after a few years of pandemic disruption, it can be hard for Wall Street to distinguish between an economy that’s running too hot and one that’s already starting to freeze up mere weeks after the first interest rate hike since 2018.

Let’s take a step back and look at some historical comparisons. First, unemployment is as close as it gets to the Fed’s primary  (and rarely achieved) goal of “full employment.”

Back in the dot-com boom, we saw a few months of 3.9% unemployment when new tech companies were hiring anyone with a pulse to create whole industries.

Then in the 2005-7 expansion, unemployment hit a 4.4% floor before spiking again in the wake of the credit crash. That felt pretty good too . . . good enough to keep the Fed happy and the market rallying until the wheels finally came off.

Right before the pandemic, unemployment got down to 3.5% before whole states shut down and millions of jobs evaporated. As of now, the headline numbers suggest that the economy is back in that zone.

The job market just doesn’t get much better than this. And that means the Fed probably isn’t going to maintain a passive approach to inflation at this point.

If jobs start disappearing, Jay Powell and his fellow central bankers will jump to provide whatever support they can. But for now, the big question for investors has shifted from “how fast will the pandemic shocks heal?” to “how high can interest rates get before choking the economy?”

Think back to 2018. The Fed had finally started tightening short-term interest rates after a full decade of staying as supportive as possible.

Unemployment was hovering around 4.0% and the Fed had pushed the overnight rate as high as 2.4% . . . eight times as high as it is today. Powell decided that wasn’t good enough. He started cutting to encourage companies to create a few more jobs.

He’d do that again if pressed. Of course he didn’t have to worry about inflation back then, but his priorities are fairly clear.

Inflation is painful but tolerable when people still have jobs. Every paycheck stretches a little less from month to month, but it’s better than zero.

When those paychecks vanish entirely, the economy is in serious trouble. Powell would rather cushion the job market than kill inflation immediately with a short sharp rate shock.

And this is essential in a market where a lot of investors have no sense of how high interest rates can get before the Fed turns the car around. They’re imagining years of steep hikes, surprise tightening moves, double-digit borrowing costs.

It could happen. But in this political environment, it’s vanishingly unlikely. Go back to the 1970s and the Fed was already taking care to loosen monetary policy at the first hint of recession . . . even though it meant throwing fuel on the inflationary fire.

And with that in mind, running for shelter is not the smartest thing any investor can do. The economy is healthy, generating cash the old-fashioned way: through hard work, perseverance and innovation.

This is the kind of environment that keeps corporate profits expanding year to year. That, in turn, supports stock prices.

It’s the kind of environment that was good to stocks in 2018 and 2019. Nobody had a problem with it then. If anything, conditions are objectively better now than they were before the pandemic.

Was the economy so weak back then that the 2020 crash was inevitable, even if the pandemic hadn’t happened? Read that sentence again. To me, it’s a little absurd.

But if you truly believe the economy is too weak now to support a few rate hikes without triggering an instant recession, that’s the argument you’re making.

The job market is if anything too strong for comfort. Rates are if anything too low to keep prices stable. Cooling the job market a little will moderate wage inflation, while higher interest rates can ultimately help a little from the commodity side.

It’s a balancing act. It always is. But the right stocks can actually keep up with both the Fed and inflation. I’d rather be here than hiding on the sidelines waiting for a recession that might never come.

No recession is forever. Not the Great Depression, the fallout from the 2008 crash or any of the other economic contractions that have been forgotten now.

The future will get even better than this. This is not as good as it gets. If you don’t believe that in your heart, ask yourself where the economy would be today if COVID hadn’t gotten in the way.

Things aren’t perfect. But the job market is as close as it gets. And while short-term interest rates are still extremely close to zero, long-term rates have a natural ceiling.

We saw this happen in 2018-19. Treasury yields got to 3% before the Fed started to guide rates lower again.

That’s when the yield curve “inverted,” by the way. The Fed took action then to soften any recession in the wings. They’ll do it again.