Still too tight.

Maybe you’ve had this experience: You’re getting ready for a night out with friends, so you go to the closet and search for something to wear. There, on a hanger in the back, are the go-to jeans you used to wear 10 or 15 years ago when you wanted to impress. So you put them on, head out the door … and spend the rest of the night regretting it.

That happened to me on Friday night. I spent the evening listening to a great cover band absolutely nail a set list that could’ve been written for my senior prom more than 35 years ago, unfortunately too terrified to dance, breathe too deeply or bend too low.

But for the record, the jeans did look pretty good. And I imagine that’s exactly how the job market felt earlier that day, too. From the outside, Friday’s non-farm payrolls report looked great to anyone who isn’t actively cheering for recession: The U.S. economy created 336,000 new jobs in September^[1] – roughly twice as many as economists expected. What’s more, it was preceded a few days earlier by an unexpected surge in job openings that was also far higher than expected: On the last day in August, employers had 9.6 million open positions, uncomfortably close to the 10 million level that first had market-watchers so breathless two years ago when the post-COVID recovery was hitting full stride^[2].

So not a bad look at all. After all, strong jobs growth is always preferable to a collapse in jobs, right? At a minimum, it’s more evidence of the U.S. economy’s durability in the face of a rate-tightening campaign by the Fed that lately has been accompanied by a run-up in rates that has occurred of its own accord, without obvious pressure from the Fed. In Friday’s jobs report, the soft-landing crowd had something else they could point to in order to suggest that this time really might be different than past Fed tightening cycles: a still-durable jobs market.

But at this point in the cycle, the same thing is true for jobs that is often true for old jeans: Sometimes, they’re just too tight for comfort. Markets originally reacted to both Tuesday’s job openings report and Friday’s payrolls report by dropping fast, likely on fears that it would cause the Fed to do something rash like raise rates again at their next meeting in November. While Friday’s losses eventually reversed themselves when analysts got a closer look at some of the details, the conclusion was inescapable: The labor market has yet to react to the Fed’s aggressive tightening.

Or has it? If the U.S. economy is really lurching its way toward a recession, one logical place we might begin to see it is in weekly claims numbers, layoff figures, or deeper inside the payrolls report with esoteric measures like the number of discouraged and underemployed workers and the proportion of those working only part-time because they can’t find an acceptable full-time gig. For what it’s worth, most of those measures are notably quiet, too, with few reasons to suspect a big decline in joblessness is right around the corner.

And that might be comforting – at least sort of. But it’s also notable that in many cases job market weakness doesn’t start to show up until right before (or immediately after) a recession begins – one of the classic “long and variable lags” between when the Fed starts raising rates and the economy begins to fully get the message. And in the case of weekly claims data, joblessness tends climb well into the recession; peaking, on average, about four months after it begins.^[3]

So last week’s labor market data was sort of a good news/bad news event. On one hand, the labor market tightness provided the latest evidence of US.. economy’s remarkable durability in the face of dramatically higher interest rates, fueling speculation that we might still achieve the fabled “soft-landing” after all. But on the other hand, that same tightness (coupled with decelerating but still too-hot wage growth^[4]) means that it’s probably too soon for the Fed to completely let down its guard with regard to inflation.

Meanwhile, in the background to all this are decades of history suggesting that a surge in joblessness – the true pain associated with any recession – rarely coincides perfectly with the onset of recession and often continues to worsen well after it arrives. Little wonder, then, that markets didn’t really know what to make of the job market data we got last week.

So when, if at all, will the labor market finally get the message? Again, the ongoing auto workers strike – joined temporarily last week by a walk-out by 75,000 health-care workers against hospital giant Kaiser Permanente^[5] – might tell you more about the state of labor than any figures published by the BLS or anyone else because ongoing negotiations provide a real-time look into how bold both sides are willing to be. A willingness to remain on the picket lines might suggest labor leaders believe they still has the upper hand, while a continued willingness to allow productive capacity to remain idle might illustrate that management believes trends are finally softening in their favor. The jury, obviously, is still out.

And then there were last week’s second most interesting economic datapoints behind all the labor data: the Purchasing Managers’ Indices, or PMIs. As suspected, the manufacturing sector is continuing to weaken (albeit at a slower pace than in the recent past^[6]). Also as suspected, the services sector is hovering right near neutral, beset by falling demand and renewed price pressures and threatening to tip into contraction^[7]. But what’s interesting is that in both cases – manufacturing and services – hiring activity has never really turned decisively negative as demand has slowed. The implication, obviously, is that all these new employees are being used to whittle away lingering backlogs of work built up throughout the post-pandemic economic recovery. But those backlogs are slowly being worked through, leading to the next most-obvious question: When all that leftover work is finally finished, is that when the hiring stops?

Before we close, a quick point about market breadth. One of the most common questions I get in this role is the extent to which recent equity market gains are being driven by a small handful of companies. You know the names, so I won’t repeat them here: We’ll just use the handle that some clever market-watcher (who also has an appreciation of classic cinema, apparently) assigned them: The Magnificent Seven. As it turns out, gains have been exceptionally concentrated among these and a handful of other mega-large, hyper-growth firms so far in 2023. In fact, the top five point-gainers in the S&P 500 this year have accounted for just over three-quarters of the total gain year-to-date (and it took only 7 or 8 stocks to account for the whole ball of wax). If you widen your lens and look instead at the last 10 years, the five biggest movers accounted for just over 25% of the S&P’s point gain, and it took more than 130 stocks to represent 100% of the market’s gain over that period.

Is that kind of concentration among the market’s haves and have-nots sustainable, especially as the economy continues to dither and volatility begins to stir? Your guess is as good as mine, but I have to admit that the bunchiness represented by the Magnificent Seven’s dominance so far this year represents a whole other level of tightness that leaves me a little uncomfortable, too.

What to watch this week

Economic events, October 9-13

Monday: Columbus Day/Indigenous People’s Day (banks and bond markets closed)

Tuesday: NFIB small business optimism

Wednesday: PPI inflation, Atlanta Fed business inflation expectations, Fed minutes

Thursday: CPI inflation, weekly jobless claims

Friday: Big bank earnings, UofM consumer sentiment

If last week was about jobs, this week will be about inflation. On Wednesday, we’ll get the latest read on producer prices in the form of the Producer Price Index (PPI), followed two days later by prices at the consumer level in the form of the Consumer Price Index (CPI). I’ve recently argued that inflation data per se has lost much of its power to persuade, just as the Fed itself has lost some of its mojo when it comes to influencing the market. I still believe that: In my view, it would take a pretty big surprise on either side of market expectations to create a significant and lasting impact on market sentiment at this point. For that reason, more interesting to me are inflation expectations – if they remain as well-anchored as they have in recent months, the Fed will have less to worry about. We’ll have two opportunities to test that theory beginning with business inflation expectations on Wednesday with the Atlanta Fed’s always-interesting survey, followed by Friday’s first look at Consumer Sentiment from the University of Michigan and its standard question about inflation expectations at the consumer level.

That said, the chances that this week’s CPI or PPI data might actually deliver some kind of market-moving surprise has been ratcheted ever-so-slightly-higher in recent weeks by higher energy prices and persistent wage pressure, two things that also made guest appearances in last week’s PMI data. If inflation data reasserts itself and suddenly starts pushing markets around again, wage pressure and/or energy prices will probably be why.

Next up on the list of things to watch are two separate reads of sentiment: the National Federation of Independent Business’ small business sentiment survey on Tuesday, followed by the above-mentioned mid-month read of consumer sentiment by the UofM on Friday. While consumer attitudes have begun to soften again, business sentiment has remained remarkably durable (as seen in recent PMI reports, regional Fed manufacturing surveys and elsewhere.) Because economic growth can only occur where optimism reigns, these types of surveys will deserve more attention in the coming months.

Finally, Friday will mark the unofficial beginning of third quarter earnings season when a handful of large banks including Citigroup, JPMorgan Chase and Wells Fargo release results. Big banks are always interesting because they sit at the crossroads between the real economy and the financial one. Bank executives are also always good for a quotable zinger or two during their post-results press conferences. This time around, though, look to banks’ actions and not their words as an indication about where the economy might drift from here. Particularly interesting will be any indication of how willing banks are to lend – which has been on the wane for several quarters running – as well as provisioning activity related to credit losses – which has been on the increase for just about as long. Both items provide a great read-through into the macro environment: loan growth because bank lending is a direct source of the leverage an economy needs to keep growing, and provisioning activity because it’s a direct reflection of how much pressure bank executives think their customers will face if the economy indeed tips over.