Here’s why good jobs news is bad news for the Fed and the stock market

Wall Street can be confusing. Sometimes good news is good news for the stock market. Sometimes bad news is good news. Sometimes bad news is bad news. And finally, some times good news is bad news. The good-news-is bad-news theme was an overarching reason behind Friday’s sharp sell-off in stocks and the sharp increase in bond yields. The good news was that the nation’s unemployment rate dropped to 3.5% in September when it was expected to hold steady at 3.7%, according to data released Friday morning. This is good for Main Street that fewer people are out of work. But it’s bad for Wall Street because it’s more evidence of a tight labor market and a signal the Federal Reserve won’t be able to lighten up on its aggressive campaign of interest rate hikes. The Fed’s dual mandate After all, the reason the Fed is hiking rates to begin with is to slow the economy in an effort to get inflation back down to its targeted 2% range. But if economic data, like the jobless rate, comes in better-than-expected, it means the economy is still chugging along and the Fed must take further action to slow things down. The central bank has raised rates by 75 basis points at three meetings in a row. With little to persuade the Fed otherwise in Friday’s jobs numbers, the market expects another raise of 75 points at November’s meeting. The need to cool the job market may seem counterintuitive because the Fed’s dual mandate calls for maximizing employment and fostering price stability. The job market has been strong so central bankers only need work on inflation, right? Unfortunately, the two pillars of this dual mandate can work against each other. We want low unemployment. But when it’s rock bottom, like it is now, what you get is wage inflation on top of already stubbornly high prices. Employers are forced to bid up wages in order to successfully attract talent — again, good for Main Street. However, the Fed has to stop that. As we’ve discussed in the past, when consumers get too flush, they spend more. In this current environment, this vicious cycle has too many dollars chasing too few goods and driving prices higher. That’s even without considering the added inflationary pressures of elevated commodities due to geopolitical factors or increased supply chain costs due to shortages and bottlenecks. Spiraling inflation is bad for everyone, especially for regular folks. That’s why the Fed has to put the brakes on it, which is bad for the stock market. How to cool wage inflation In addition to the unemployment rate decline, the government’s September jobs report showed that average hourly earnings — wage inflation — rose 5% year over year. While a tick below expectations, it was still very high versus pre-Covid pandemic levels. This combination of low unemployment and high wage inflation is problematic for the Fed because it feeds overall inflation. One part of the jobs data, if it were to be looked at by itself, could be viewed as softer. Only 263,000 nonfarm payrolls were created in September, the lowest level since April 2021 and below expectations. It was also far below August’s 315,000 and July’s 537,000. However, the addition of 263,000 last month wasn’t so bad — remember bad would be good for stocks — to buoy the market. As a result, the market expects the central bank to maintain its hawkish stance and continue raising rates at a record pace. From an economic perspective, inflation poses a far greater threat than 4% unemployment, and the Fed is intent on making that trade off via continued rate hikes. To this point, according to the CME FedWatch Tool , the probability of a 75-basis-point Fed rate hike in November now stands at over 80%, up from around 75% coming into the jobs report. Rising rates erode stock values Higher rates pose a problem for equity valuations in a few ways. On the one hand, bonds are finally, for the first time in a long time, offering a return — risk-free in the case of government-backed U.S. Treasurys — high enough to draw funds away from the stock market. At the same time, using a discounted cash flow valuation model , we see the present value of future cash flows reduced, which in turn makes a company’s stock less attractive. In terms of the market action, higher rates are certainly more negative for high multiple stocks — think those secular growers that make little to no money now with promises of big profits far out in the future. Even the lower-value, money-making cyclicals are under pressure because the second major fear behind inflation is that the Fed is going to rate hike the world right into a recession, which hurts everyone. There is a lag between Fed action and the impact seen in the actual economy. Bottom line The Fed is in a very difficult spot. If it doesn’t hike enough and inflation isn’t addressed, then purchasing power continues to erode. If they hike too much, they can push the economy into a recession. This jobs print demands the central bank take action to address the former. On the other hand, there are signs that past actions are working, which is why investors fear the Fed may be acting too aggressively. On Thursday, Club holding Advanced Micro Devices (AMD) warned of weaker-than-expected sales for the third quarter, the latest in a growing list of companies to guide down going into earnings season. These announcements are noteworthy because they show that companies are being forced to lower prices in order to liquidate inventory due to declining demand and a consumer less able to accept high prices. Unfortunately, we won’t know if the next hike is warranted until well after the action is taken. But the one thing investors hate more than bad news is uncertainty. The action in the market Friday speaks to the incredible amount of uncertainty swirling around the world — from the appropriateness of the Fed’s continued hawkishness to Russia’s war in Ukraine and China’s slow and halting reopening plan. (Jim Cramer’s Charitable Trust is long AMD. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.