This week the Bureau of Labor Statistics announced employment data, showing that the US economy added 209,000 jobs in June, wages rose more than expected (up 0.4% to $33.58/hr average), and the unemployment rate dropped slightly to 3.6%. This is all ostensibly good news, insofar as US workers and the US economy seem to be doing quite well. But the stock market went down on the news, and not because the numbers were lower than expected, but because they came in slightly above expectations. That is, the labor economy is doing better than aggregate expectations, and yet the response in the stock market is negative. This is a bit unintuitive, but there is straightforward reasoning behind it.
Wages Come From Profits
Wages are a cost to business, and so all else equal if wages are rising faster than inflation (i.e., faster than prices) then profit margins will fall, presumably dragging down stock prices with them. The only exception is if overall economic productivity is rising even faster than wages. That is, if a business is able to pay 1 worker to produce 10 widgets per day, and the technological advancements allow that 1 worker to produce 12 widget per day, the business can now afford to pay the worker a higher wage, even while maintaining healthy profit margins. (That is obviously an extreme simplification).
The Impact of Rising Demand
Higher real wages (wages growing faster than inflation), creates more purchasing power for consumers; people will just have more money to spend. This should generally increase demand throughout the economy, driving prices higher. From there, several bad things can happen:
- Increased Inflation: As prices rise, inflation rises.
- Asset Bubbles: Increased disposable income means more people have money to throw around on speculative assets that they may otherwise not have considered. This can lead to asset bubbles that tend to cause net economic harm once they've popped. (That is, it would be preferable to have slow, constant growth, rather than bubbles with huge spikes and subsequent crashes in prices).
The Implication on Interest Rates
Perhaps the most significant reason for the stock market's adverse reaction to robust labor growth is the signal it sends to the Federal Reserve. It indicates that the economy is thriving despite the Fed's substantial interest rate increases over the previous year. When the Fed began raising rates last year, it was because inflation had grown far too high and the US economy was overheating - that is, it was actually too strong. By raising rates, the Fed has attempted to slow things down, to 'hurt' the economy so that growth slows down to a more sustainable and less volatile rate. But strong jobs data suggests that the Fed still isn't doing enough, and that more rate increases are coming. And if there's one thing stocks hate, it's rising interest rates.
In the end, the core challenge for the Fed is to thread the needle such that the US economy continues to grow at a healthy and sustainable rate.