The robust job market, driven by immigration, presents a conundrum for the Federal Reserve. The U.S. job market continues to exceed expectations, with September witnessing the creation of more new jobs than any month since January. Employment has seen growth in most sectors, except for financial services and information. Meanwhile, the unemployment rate remains steady at 3.8%. Initial claims for unemployment insurance, while showing a slight increase last week, have stayed at levels not seen since January. Despite facing some headwinds, the U.S. economy has maintained its momentum as the third quarter draws to a close. It is widely anticipated that the upcoming GDP growth report for the third quarter will be robust. The current question centers on how the Federal Reserve will interpret this data.

To delve into the specifics, the U.S. government releases two job market reports—one based on surveys of establishments and another based on household surveys. The establishment survey reveals that September saw the creation of 336,000 new jobs, marking the most substantial increase since January. Furthermore, the government revised upward the job gains for July and August by a combined 119,000, suggesting that the softening of the job market may not have been as pronounced as initially thought.

Looking at individual industries in September, there was a notable increase of 17,000 jobs in the manufacturing sector, including 8,900 new jobs in the automotive industry. Despite the auto worker strike beginning on September 15, this sector demonstrated resilience. Retail employment saw an increase of 19,700, transportation and warehousing showed a modest gain of 8,600 jobs, information saw a decline of 5,000, and financial services experienced a meager increase of 3,000. Some industries, however, enjoyed more substantial gains. For instance, professional and business services saw an increase of 21,000 jobs, healthcare and social assistance surged by 65,900, leisure and hospitality saw a significant increase of 96,000, and government employment rose by 73,000, primarily at the state and local levels.

The government also reported that average hourly earnings for private sector workers in September were up 4.2% compared to the previous year, marking the smallest increase since June 2021. Despite this moderation, wage inflation has not significantly eased since March, and a survey by the Conference Board indicates that most employers anticipate offering 4.1% wage increases in 2024. This suggests that the Federal Reserve may need to take further action to curb inflation.

The household survey revealed that employment growth has closely aligned with the growth of the working-age population, leading to an unchanged participation rate and unemployment rate. Despite robust post-pandemic employment growth, it still falls short of the trajectory it would have followed without the pandemic’s disruption and a steady job growth rate. One reason for this gap is that participation, while recovering from pandemic lows, remains below pre-pandemic levels. Prior to the pandemic, the participation rate was at 63.3%, whereas today it stands at 62.8%. With the job market tightening, achieving faster employment growth would likely require a significant increase in participation or immigration.

Speaking of immigration, it has been accelerating and contributing significantly to the strong job growth. Since April 2020, over half of the job growth in the United States has been attributed to foreign-born workers, with industries like healthcare, social assistance, and leisure and hospitality benefiting the most. Construction employment has also seen robust growth, primarily driven by foreign workers. If this trend continues, immigration may expand the labor force relative to labor demand, thereby mitigating wage inflation. Notably, in the decade preceding the pandemic, immigration accounted for half of the U.S. population growth. It temporarily halted during the pandemic but is now rebounding.

Following the release of the jobs report, bond yields initially surged but partially retraced. In the futures market, the implied probability of a Federal Reserve rate hike before the end of the year increased from 40% the day before the jobs report to 50% afterward. The Federal Reserve has long signaled its intention to cool the labor market to control wage inflation, but robust job growth may necessitate further action. However, the surge in immigration could be partially fulfilling the Fed’s goal. Additionally, if upcoming inflation data proves favorable, the Fed might choose to maintain its current course.

It’s crucial to consider that monetary policy typically operates with a time lag. Elevated interest rates are already affecting various sectors of the U.S. economy. Consequently, the economy is likely to decelerate in the coming months, even without additional rate hikes. High mortgage rates have hindered the housing market, elevated auto loan rates have increased the cost of car purchases, and high bond yields are constraining companies’ ability to raise funds for investments or transactions. Thus, the Fed may decide against raising rates.

Bond yields are rising in most advanced economies, including the United States, Germany, and Italy. This reflects growing optimism about economic growth, driven by better-than-expected economic data, and central banks’ intentions to keep interest rates elevated for an extended period. Some observers speculate that the increase in bond yields may also stem from concerns about the sustainability of fiscal policies, particularly in countries like Italy. In the United States, there’s unease about the relatively high budget deficit despite low unemployment. Rising U.S. deficits, coupled with higher bond yields, may lead to competition for funds between the government and businesses looking to invest. This increased demand for capital could exert upward pressure on borrowing costs.

The upsurge in bond yields has contributed to a decline in equity prices. If bond yields continue to rise, it could negatively impact business investment, M&A activity, housing markets, and asset prices, potentially leading to decreased consumer spending due to reduced wealth perception.

Furthermore, the high yields on U.S. bonds have strengthened the U.S. dollar as global investors seek high returns and safety in U.S. government bonds. U.S. real yields are higher than those in Europe due to lower U.S. inflation and faster economic growth. This has put pressure on the euro and the pound. Although the Japanese yen briefly crossed the 150 yen per dollar threshold, the threat of Japanese government intervention prompted investors to be cautious, and intervention may be on the horizon.

A strong U.S. dollar is expected to help control inflation by lowering import prices. However, it could potentially harm the competitiveness of U.S. exports over time. Conversely, a weaker yen in Japan may boost export competitiveness but contribute to inflation through higher import prices. In Europe, weaker currencies can exacerbate inflationary pressures.

After a significant surge that contributed to a rebound in U.S. inflation, oil prices have started to decline. From late June to late September, Brent crude oil prices rose by about 30% due to supply reductions by Saudi Arabia and Russia. However, this was not driven by increased demand but by supply constraints. The rise in gasoline prices, a result of higher oil prices, contributed to an uptick in inflation, while core inflation slowed.

The recent decline in crude oil prices, which have fallen approximately 11% since September 27 to around $84 per barrel, can be attributed to several factors. Investors anticipate weakened demand due to prolonged high interest rates and expect that elevated oil prices will curb demand further. Indicators suggest a global economic slowdown is underway. Investors also speculate that OPEC and Russia may increase production to maintain higher prices, though there are concerns about their ability to reach a consensus.

Additionally, there’s the possibility that some OPEC members might cheat on production cuts, as has occurred in the past. When OPEC has agreed to reduce production to raise prices, certain members have increased production to take advantage of higher prices, putting downward pressure on oil prices.

Looking ahead, a further decline in oil prices seems more likely than an increase. This decline could reverse the temporary inflationary impact seen in recent months, with potential implications for central bank policies.

In the Eurozone, real retail sales have been on a downward trend since the end of 2021. August saw a rapid decline, with retail sales volume falling by 1.2% compared to July and 2.1% from the previous year. This decline was observed across various retail categories, including nonfood merchandise, food products, mail order/internet sales, and automotive fuel. Despite rising real wages and low unemployment, the consumer sector remains weak.

The drop in automotive fuel sales is attributed to a significant increase in petrol prices, which, in turn, impacted discretionary spending on other items. Additionally, home prices in the Eurozone have declined for the first time in a decade, largely due to high interest rates. This decline in home prices has negatively affected the turnover of housing and, in turn, retail sales. Lower home prices also translate to reduced household wealth, further impacting consumer spending.

Across Eurozone countries, Germany, France, and Belgium witnessed notable month-to-month declines in real retail sales, while Spain and the Netherlands saw more modest changes.

In the United States, mortgage applications for home purchases have seen a sharp decline, primarily driven by exceptionally high mortgage interest rates. In the week ending September 29, new mortgage applications were down by 6% compared to the previous week and down by 22% compared to the same period the previous year. Purchase market activity reached its lowest point since 1995. Furthermore, applications for mortgage refinancing fell by 7% from the previous week and by 11% from the previous year.

The weakened demand for new mortgages has repercussions for home prices. Despite a recent increase in home prices, this is not due to strong demand but rather a result of limited supply. High mortgage interest rates have discouraged existing homeowners from selling their homes, as purchasing a new home becomes considerably more expensive. This supply constraint has led to higher prices, with the price surge also prompting increased construction of new housing units.

The slowdown in housing transactions has spill-over effects on related industries, particularly those providing home-related goods and services such as appliances, furniture, home entertainment, and home improvement products and services. These transactions are typically conducted through the retail sector. Consequently, weakness in housing can contribute to overall retail weakness. On the flip side, households postponing housing transactions might opt to allocate more of their budgets to services such as travel, dining, entertainment, and home improvements.