Federal Reserve Chair Jerome Powell’s annual Jackson Hole speech on Friday set the tone for the financial markets this week, outlining three crucial tests that economic data must pass to avoid additional rate hikes. The first of these tests was passed on Tuesday when the Job Openings and Labor Turnover survey revealed that job openings have dropped to their lowest level in over two years, a development that saw the S&P 500 surge as the 10-year Treasury yield dipped. The next tests will be the release of the Fed’s primary inflation rate, the PCE price index, on Thursday, and the August jobs report on Friday morning.

In a sign that the labor market might be returning to pre-pandemic conditions, payroll processor ADP estimated that private-sector firms added 177,000 jobs in August, the lowest number since March. However, it is worth noting that these ADP estimates do not align closely with Labor Department data on a month-to-month basis. Despite this, the S&P 500 futures pointed slightly higher in early Wednesday stock market action, following the ADP employment report. Meanwhile, the Labor Department reported a significant drop in posted job openings in July, marking the lowest number since March 2021, before inflation began its upward trajectory.

Labor Market Cools: What This Means for the Economy

Federal Reserve Chair Jerome Powell’s annual Jackson Hole speech on Friday outlined three tests that incoming data must pass to avoid additional rate hikes. On Tuesday, the Job Openings and Labor Turnover survey passed Powell’s test with flying colors as job openings slid to their lowest level in more than two years, leading to a surge in the S&P 500 as the 10-year Treasury yield dived.

Job Openings Fall

The Labor Department reported a drop of 338,000 job openings in July, down to 8.8 million – the lowest since March 2021, before inflation surged. Even the quits rate, the percentage of workers quitting their job in a given month, slipped to 2.3%, the lowest since January 2021. According to ZipRecruiter chief economist Julia Pollak, the labor market is largely back to pre-pandemic conditions, which she believes will come as a relief to many employers.

Fed Rate-Hike Odds Fall

Amid signs that the economy may not be cooling as expected, Powell’s recent speech showed a more hawkish tilt. He did not suggest that more rate hikes are likely, but made it clear that the status quo won’t suffice. The economy needs to cool down quickly as the Fed is low on patience. Odds for a rate hike by the Nov. 1 meeting climbed to 62% on Monday but have since tumbled back to 41% amid evidence of labor market cooling.

Powell’s Three Tests For Economic Data

Powell’s three tests for the economy are: evidence of persistently above-trend growth that could put further progress on inflation at risk, evidence that the tightness in the labor market is no longer easing, and placing emphasis on inflation in nonhousing services. This week’s data will update progress on all three of Powell’s key tests.

PCE Inflation And Jobs Reports

The outlook for third-quarter GDP growth could shift with the Commerce Department’s personal income and spending report for July. The annual core PCE inflation rate is forecast to tick up to 4.2% from 4.1%. Wall Street will also pay close attention to nonhousing services prices, Powell’s third test. Today’s JOLTS data and Friday’s jobs report will track Powell’s bottom line requirement: that labor market tightness needs to keep easing.

S&P 500 Rally Faces Economic Test

The S&P 500 rallied 1.45% to 4497.63 in Tuesday stock market action, while the 10-year Treasury yield tumbled 9 basis points to 4.12%. More evidence that a soft landing for the U.S. economy is within reach may be needed to allow the S&P 500 to continue its ascent.

Takeaways

The cooling labor market is a positive sign for the economy, indicating a return to pre-pandemic conditions. Powell’s tests for the economy will be crucial in determining future monetary policy. The focus will now be on the PCE Inflation and Jobs Report, which could potentially impact the S&P 500 rally. The economy appears to be on the path to a soft landing, but continuous monitoring and strategic policy decisions will be critical in ensuring stability.