According to the Bureau of Labor Statistics, total employment rose by 517,000 in January, blowing economist expectations out of the water — analysts forecasted a 187,000 increase in jobs for the month. Despite the onslaught of reports of major companies’ layoffs, the US economy’s job growth was resilient during the first month of the year.
But even with this economic good news, the stock market has pulled back since the February 3 jobs report. Before this report, the S&P 500 gained about 9% for the year. However, since the employment data release, the S&P 500 has fallen about 2%.
This disconnect between better than expected economic data and stock market losses can be confusing to some investors. After all, shouldn’t a robust job market be a positive for the stock market, as it suggests the economy is growing, businesses are hiring, and consumers have jobs and spending power? But this isn’t always the case, and sometimes good economic news can be bad news for the markets, especially these days. Here’s why.
It’s All About Inflation and Interest Rates
One of the most significant ways good economic news can negatively impact the markets is through interest rates. If job and wage growth is rising and consumer spending is robust, the Federal Reserve may raise interest rates to keep inflation in check and keep the economy from further overheating.
These moves can be bad news for the markets because higher interest rates make it more expensive for companies to borrow money and for consumers to take out loans, which can slow economic growth and cause stock prices to fall. Moreover, higher interest rates make other assets, like bonds, more attractive to investors than more speculative growth assets like stocks.
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How Did We Get Here?
Inflation has spiked during the past two years as supply shocks and stimulated demand related to the Covid-19 pandemic upended the economy. The Federal Reserve has been aggressively raising interest rates over the past year to combat rapidly rising prices, pushing the federal funds rate between 4.5% and 4.75% earlier this month, a 15-year high.
This tight monetary policy campaign seems to have helped curb prices — inflation rose 6.5% year-over-year in December 2022, down from a high of 8.9% in June 2022.
But at the same time, the stock market has paid the price for high interest rates — the S&P 500 fell about 19% in 2022, and the tech-heavy Nasdaq Composite index, which is much more sensitive to interest rate changes, fell 33% for the year.
Inflation is much higher than the Fed’s preferred target of 2%. Still, investors have expected the central bank to ease its interest rate hikes as it navigates an attempt to reduce inflation without putting the economy into a recession.
Before the January jobs report, investors expected the Fed to stop rate hikes after its March FOMC meeting and possibly cut rates in the second half of the year. The anticipation for lower rates helped buoy stocks to start the year.
However, the strong January jobs report may have changed the Fed’s calculus, and further rate hikes may still be in the cards. Economic theory states that inflation cannot come down significantly with a robust job market. So, right now, good economic news — such as job and wage growth, low unemployment, and other labor market indicators — may fuel this high inflation and make the Fed increase interest rates further than investors anticipated. With higher interest rates comes a likelihood of lower stock prices and bad news for the markets.
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Good economic news, like low unemployment, increasing consumer confidence, and rising gross domestic product (GDP), is typically seen as positive for the markets. But during times of high inflation, some good economic news, such as robust job growth and high wages, can lead to some negative impacts in the markets. Anything that may add fuel to rising prices may lead the Fed to continue raising interest rates, weighing on the stock market. Investors need to be aware of these factors when making investment decisions.
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