The release of the January nonfarm payrolls (NFP) report from the Labor Department was expected to push crude prices higher, due to the traditional correlation between job growth and energy demand. However, this time around, the report did not have the expected impact on oil prices. Despite the impressive job growth of 517,000 in January, which was almost three times the forecast, crude prices actually dropped by 7% due to the rapid surge of the dollar and uncertainty surrounding interest rates.
The relationship between unemployment and inflation is not as simple as it seems. Historically, there has been a strong positive correlation between jobs and crude prices, as a greater number of people with jobs would logically lead to higher demand for transportation fuels, including gasoline. However, the recent NFP report and the subsequent oil market crash showed that the inverse relationship between unemployment and inflation can break down.
The unexpected job growth threw a fresh challenge to the Federal Reserve, which had hoped that its aggressive rate hikes over the past year would have cooled the labor market and wages to get inflation back to its target. The central bank has increased rates by 450 basis points in a monetary tightening cycle that began in March 2022, two years after the coronavirus outbreak. This outbreak led to trillions of dollars in relief spending that pumped up the economy and triggered runaway inflation.
The Fed’s monetary tightening cycle was successful in slowing down inflation, as measured by the Consumer Price Index (CPI). Inflation hit four-decade highs in June at 9.1% yearly, but by December, the CPI grew at its slowest pace since October 2021, at 6.5% per annum. Despite the slowdown, inflation was still more than three times the Fed’s target of 2% per annum.
However, Fed Chair Jerome Powell saw fit to say that “for the first time, the disinflationary process has started” and that “we can see it really in goods prices so far.” Powell’s statement came after the NFP report, which led to a rapid surge in the dollar and yields on the U.S. 10-year Treasury note. These two factors acted as contra trades against risk assets, including stocks and commodities, and could continue rising if the Fed reconsiders its plan to further consolidate rate hikes this year.
Oil prices were already on the back foot before the NFP report due to a sixth straight weekly build in U.S. crude, along with surpluses in fuels, reported by the Energy Information Administration (EIA). The EIA reported a total crude build of 34.5 million barrels over the past six weeks, with crude stockpiles at their highest since June 2021. The EIA also reported builds in gasoline and distillate stockpiles, with gasoline inventories up by almost 13 million barrels since the beginning of 2023.
“Commercial storage in North America is ample,” says Norbert Ruecker, economist at Julius Baer. “The improved market mood has lifted prices of late, but the fundamentals remain bearish, particularly with the recent builds in crude and gasoline stockpiles.”
The oil market crash showed that good jobs numbers are no longer a guarantee for higher oil prices in the post-pandemic world. The complex interplay between unemployment, inflation, the dollar, and interest rates means that there are multiple factors that can impact oil prices. The recent NFP report and oil market crash also highlight the importance of considering the broader economic and financial landscape when analyzing the impact of economic data on different markets.
In conclusion, the release of the January nonfarm payrolls (NFP) report from the Labor Department showed that the relationship between unemployment and inflation is not as straightforward as it seems. Despite impressive job growth of 517,000 in January, oil prices dropped by 7% due to the rapid surge of the dollar and uncertainty surrounding interest rates. The recent NFP report and oil market crash highlight the importance of considering the broader economic and financial landscape when analyzing the impact of economic data on different markets. The complex interplay between unemployment, inflation, the dollar, and interest rates means that there are multiple factors that can impact oil prices and the historical positive correlation between jobs and crude prices may not always hold true. The recent events have thrown a fresh challenge to the Federal Reserve and its monetary tightening cycle that was intended to cool down the labor market and bring inflation back to its target.