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This fundamental is currently moving the markets

Although 2022 has been very generous to volatility-seeking traders, a phenomenon has begun to emerge in recent weeks that makes prediction more difficult than usual. In today’s article, we will explain what this phenomenon is, how it affects the markets and how to learn to read it.

Low unemployment rate as a friend of inflation

A strong labor market is the foundation of any healthy economy, we can probably all agree on that. More people are employed, have a regular income, and thus consumption grows. But higher consumption also leads to inflationary pressures, which is something no one wants in the current situation (October 2022). That is why too strong a labour market is currently perceived negatively. On the other hand, negative news such as an increase in unemployment claims or a lower than expected number of new jobs is positive for the markets. How is this possible?

Everything is related to the monetary policy of central banks. They are currently raising interest rates practically all over the world, which in turn makes credit more expensive. The aim of this action by the central banks is to reduce consumption and gradually reduce prices. This whole process takes months or years, of course. If interest rates are rising in the market and consumption is falling, then the logical outcome of this situation is redundancies. Companies are not selling the expected quantities of their products and, instead of expanding their production and recruiting new employees, they have to resort to the opposite. The unintended side effect is an economic slowdown, which is practically inevitable in order to reduce inflation.

If unemployment is rising and the number of new jobs is falling, this is a signal that the current level of interest rates is restrictive for the economy. In this case, the market is thus looking ahead and assuming that the central bank will not have to tighten monetary policy as strongly as might have been expected. This is of course positive in the long run - it means a gradual reduction in inflation and also the prospect of interest rates being cut again, which will then stimulate higher consumption and economic growth once more. The reality is not always so straightforward, of course, but economic theory speaks clearly.

How did we get here?

To answer this question, we have to look more than 2 years into the past. The clear culprit is the coronavirus pandemic. It practically brought the world to a standstill for a few months. Global economies had to print record amounts of money to support people and an impoverished economy. People used this money to consume and buy various assets, which logically had to be reflected in inflation. And we are now paying the price. Its pace has then been greatly accelerated by the war in Ukraine, which has caused literally chaos in the energy market.

However, a time bomb is also currently ticking in the US labor market. In addition to mass layoffs, new jobs were created during the pandemic. Thus, while around 22 million workers in the US lost their jobs, a large number of them found work again, sometimes even in a different field. But the pandemic is on the wane again, and the companies that made redundancies during the pandemic are now desperately looking for a new workforce. The resulting situation in the US labour market is so desperate that there are two job openings for every unemployed US citizen. Labor market of such strenght is truly alarming.

The impact of unemployment on the stock market and US dollar

The US market has record low unemployment - around 3.5 %. Around 263,000 new jobs were created in the US in September, which is more than expected. As a reaction to this, US stock markets fell by a certain margin. You can see the detailed reaction of the Nasdaq technology index to this news in the chart below (marked by the red arrow). Such a tight labour market indicates that the US Federal Reserve is likely to tighten monetary policy at an initially unconstrained pace. Stock markets may thus come under further pressure. Conversely, the US dollar may strengthen steadily.

Traders should keep a close eye on traditional fundamentals such as Thursday's jobless claims statistics, where a significantly higher than expected number could be positive for stock markets. Also important is the monthly Manufacturing ISM index (economic activity among manufacturers). Higher unemployment claims and lower economic activity among manufacturers can be positive for stock markets. Such a situation occurred last week and its effect on the Nasdaq index is shown by the green arrow below.

Nasdaq reaction to labor market fundamentals in the week of October 3 - October 9, 2022Nasdaq reaction to labor market fundamentals in the week of October 3 - October 9, 2022

Could better days be ahead of us?

The light at the end of the tunnel may be the fact that the current level of interest rates seems to be working. While the US economy added more jobs than expected during September, the month-on-month pace is downward. The reading was even the lowest since April 2021. You can see the monthly new jobs statistics in the chart below.

In addition, unemployment claims rose to 219,000 last week, 16,000 more than expected. While the U.S. labor market remains strong, it appears to be starting to cool off gradually. Investors who are good at gauging the markets' reaction to published fundamentals can thus generate interesting profits. The current volatility thus favours active trading in the US indices.

Monthly statistics on new jobs in the US. Source: CNN
Monthly statistics on new jobs in the US. Source: CNN