Tight Labor Market, Solid GDP Growth Support Fed’s Argument for Higher Rates

A pre-market rally in the benchmark S&P 500 Index and the NASDAQ Composite on Thursday faded after data showed the U.S. economy rebounded more than expected in the third quarter. Meanwhile, weekly jobless claims increased less than expected, pointing to a still tight labor market.

The sell-off in U.S. equities indicates that good economic news is now bad news. In other words, it doesn’t matter how strong the economy is, what matters is, how it will affect Fed policy.

Today’s economic numbers revealed that growth was stronger than expected, which means inflation was fairly persistent. And that’s bad news for investors because it means a Federal Reserve pivot in its interest rate hike campaign will not be forthcoming. Furthermore, it likely strengthens the case for more aggressive rate hikes until there are signs of the economy slowing down.

More Signs of US Labor Market Tightness

Shortly before the cash market opening on Thursday, the U.S. government reported that the number of Americans filing new claims for unemployment benefits increased less than expected the week-ending December 17. The news is pointing to a still-tight labor market.

Initial claims for state unemployment benefits rose 2,000 to a seasonally adjusted 216,000 last week, leaving the bulk of the prior week’s decline intact, Labor Department statistics showed.

Economists polled by Reuters had forecast 222,000 claims for the latest week. Claims have moved up and down in recent weeks, but have remained below the 270,000 threshold, which economists said would raise a red flag for the labor market.

Government Report Shows Solid Economic Growth

A second report from the Commerce Department on Thursday confirmed the economy rebounded in the third quarter after contracting in the first half of the year.

Gross Domestic Product (GDP) increased a 3.2% annualized rate last quarter, the government said in its third estimate of GDP. That was revised up from the 2.9% pace reported last month. The economy had contracted at a 0.6% rate in the second quarter.

The government said the upward revision to GDP last quarter reflected upgrades to consumer spending, business investment as well as state and local government outlays. Domestic demand was also revised to show moderate growth instead of being tepid, Reuters reported.

Data Validates Fed’s Plan to Raise Rates

Today’s weekly initial claims and GDP reports clearly indicate economic strength is likely to continue to fuel steady inflation. Furthermore, the initial bearish reaction by stock market investors, firming U.S. Treasury yields and a stronger U.S. Dollar, support the need for the Fed to remain hawkish.

A little over a week ago the Federal Reserve hiked its policy rate by 50 basis points to a 4.25%-4.50% range, the highest since late 2007. Fed officials also said they expect the rate to rise to between 5.00% and 5.25% next year.

Today’s reports did nothing to dispel that outlook.