The Jobs Report Confirmed What We Already Knew
Jobs data came in solid and hard to argue against. It confirmed why the Federal Reserve has aimed at the inflation half of its job this year and has not worried much about employment. The report mostly restated a known fact: the economy underneath is strong, and it is strong because spending on AI and building data centers has been strong.
Rates markets may have this wrong. The world may have shifted in the last 72 hours. For the Fed, the strong economy forces a tight focus on inflation. The Fed did not raise rates in October even after saying inflation is a choice and is too high. All attention now turns to December.
One thing changed that needs close watching: how far the Democratic side will keep letting the AI and data center buildout run. Without that buildout, the jobs picture would change for the worse.
Lowering Inflation Means Killing Demand
The only real way to bring inflation down is demand destruction - cutting demand in the real economy. Everyone wants to cure the disease; the question is whether they will take the medicine needed.
Part of the story behind falling rates is that a war may be ending and oil may drop. But the Fed did not hike hard as oil rose, so it will not ease off the brake if oil falls. The focus stays on the jobs number and the wage number. Look under the surface and the economy is doing well, which feeds a lot of demand. Bringing inflation down means bringing demand down, and jobs will follow demand lower. How much is unclear. The task is whether the Fed can land the plane, even if not smoothly.
A Base Case of Three Hikes
CME FedWatch futures show a chance of several more hikes. The 2-year yield sits about 50 basis points below the fed funds rate, which points to more than one-and-done, with a real chance of another move in early 2027.
Neither political party is fiscally tight right now. Markets may be misreading the split between House and president as a setup for restraint. The likely result is trade-offs - you spend on this, I get to spend on that - which keeps piling on inflationary pressure.
The problem started with too much monetary and fiscal stimulus together. The monetary side is now coming down; the open question is how much. Two hikes is a floor. The stronger bet is more. High rates could brake AI spending, since many business models do not work when rates are high. Many fiscal balance sheets, in the US and abroad - France is one example - do not work at current rates either, and the consumer is under pressure. That strain is already acting. Inflation will likely prove sticky and surprise the market, taking perhaps more than two hikes. The base case is three.
Watching the Markets Without Being Watched
The Fed wants to watch the markets without the markets watching the Fed - a clean read on what Kevin Warsh has been saying. That part of the wish will not come true. Watching the Fed is what market participants are paid to do and will do. But the Fed still has to act on its own.
The Fed has paused partly because the market has been doing its work for it. Rates have fallen a lot since the last meeting. Markets have been pricing in a sharp drop in future inflation even though that drop has not shown up, and the jobs data gives no sign it is coming, outside of oil. The Fed will have to step up and act as the counter stimulus to a very strong economy.
Warsh says he looks out the window, but he was surely watching a very red screen in markets. The Fed is seeing the jobs report, the toughness of the economy, and oil starting to bleed into the real economy through producer prices and elsewhere even if it eases.
The path forward: raise rates in December, possibly by 50 basis points. There has already been some softening in the rhetoric against AI and a recognition that AI is powering the economy. How you campaign differs from how you run the administration. The Fed is on a path of monetary tightening. Why it skipped October is unclear, but it should move in December and again in early next year, unless the tightening finally works and demand destruction appears. For now, that is not happening.
The Opportunity in Fixed Income
Markets may be overlooking a large opportunity in bonds. Fixed income is now a strong rival to stocks. High-quality fixed income pays about 6.5%. Step slightly down in quality and you reach the low 7s. Some data center buildout debt yields 7.5% to 8% while still carrying investment-grade, high-quality ratings.
A few weeks ago, fixed income investors were asking why anyone would own the asset class with rates rising. Now some may fear they missed the boat. They have not. With a resilient economy and spreads that have widened, there is a strong case to move into fixed income, especially if higher rates bite and the world turns into a less safe place - something likely in the near future.
