For several weeks, financial markets have been waiting anxiously for Fed Chairman Powell’s speech in Jackson Hole, hoping that it will give them some perspective on interest rate developments. Even more concern arose on Wednesday, when the nonfarm payrolls (jobs) were revised down sharply by -818,000 (see below). To illustrate the fear in the equity sector, at the close of trading on Thursday (22 August)and), the main averages for the week remained unchanged (middle column of the table).
Stock markets
On Friday, when the usually combative Chairman Powell gave a dovish speech, the markets celebrated, especially the small caps. Note that the Russell 2000 was up 0.38% for the week on Thursday, but ended Friday up 3.58%. A look at the table also tells us:
- The Dow Jones closed just below its all-time high of 41,191.08 reached on July 17.th (rightmost column).
- The S&P 500 is also only centimeters away from a new record high (5667.20).
- The technology-heavy Nasdaq is up this week, but is still more than -4% below its July 10 level.th peak, suggesting that enthusiasm for technology stocks is waning.
- A look at the next chart (the glorious 7) shows why the tech-heavy Nasdaq is lagging, more than -4% from its record high. Note that Nvidia (NVDA) is the only one of the seven to close with a new high on Friday, while MSFT, AMZN, TSLA and GOOG are still down double digits from their July highs. A simple average for all seven shows that they are still down nearly -8% from their July highs. Market sentiment has clearly turned away from “tech.”
The Magnificent 7
What happened to these jobs?
Before Powell’s speech, and perhaps a major influence on it, on Wednesday, August 21stthe Bureau of Labor Statistics (BLS) announced that it has revised downward the number of Nonfarm Payroll jobs for the one-year period ending March 2024 by -818,000. This represents a -28% decline in the number of jobs created during that 12-month period, reducing the monthly job gains by a notable -68,000 per month. This was the largest downward revision for a year since 2009 during the Great Recession. It should also be noted that last August, a downward revision of -306,000 jobs was made for the April 2022 to March 2023 period.
Why such major revisions in the last two years? The most likely reason for this is the birth/death model. One might ask: “What is the birth/death model and what is the reason for including it in the monthly jobs calculations?”
The monthly nonfarm payroll number comes from a monthly survey of large and midsize businesses. In the 1990s, pressure became so great that small businesses, considered the heart and soul of the American business landscape, should also be included. So the folks at the BLS collected data and created a model that concluded that the growth of the U.S. economy and the number of small businesses go hand in hand. Today, the BLS simply adds this trend number (seasonally adjusted) to its survey of large and midsize businesses each month. It comes in at somewhere between 75,000 and 125,000 jobs per month. It’s just an extended trend line and, to the detriment of the survey, it’s not affected by current economic conditions.
Of course, there is market data that gives us an indication of the health of small businesses, such as the number of business bankruptcies, which is currently up 52% year-on-year and is now approaching a 10-year high, or the number of new businesses being founded, which is down 11.5% year-on-year. These data should have an impact on the Births/Deaths addition, but they don’t.
As part of the BLS’s monthly employment survey of large and midsize businesses, it also conducts a household survey of employment. This is called the household survey and is used to calculate the unemployment rate. The fact that the unemployment rate rose from 3.4% in April 2023 to 4.3% last July is another indicator that the labor market is not as strong as commonly believed. In addition, there were other indicators pointing to a cooling labor market, such as the BLS monthly Job Openings and Labor Turnover (JOLTS) survey, which showed a rapid cooling of job openings, an increase in the time it takes to find a new job after an employee is laid off, and a rising number of layoffs, as documented monthly by employment services firm Challenger Gray and Christmas.
Of course, jobs are an important yardstick for assessing economic health. As mentioned above, Fed Chair Powell has now confirmed that the Fed will begin cutting rates at its September meeting. At the time of writing, markets consider a 25 basis point cut a certainty, with the probability of a 50 basis point cut currently at 33%. Between now and the Fed’s September meeting, several key pieces of data will be released that will surely play a role in the rate setting decision (whether 25 or 50 basis points), including the August employment reports, a JOLTS, and the PPI and CPI releases.
The Fed
Minutes of the Fed’s July meeting released on Wednesday show that a rate cut was discussed. Fed observers consider the minutes to be the most dovish in a long time, at least since 2021. Therefore, Powell is expected to prepare the markets for rate cuts at the Fed symposium in Jackson Hole (Reassessment of the effectiveness and transmission of monetary policyAnd that’s exactly what he did, laying the groundwork for a significant rate cut back toward the Fed’s “neutral” level (2.75%). In his speech, he said the time for rate cuts had come, his confidence in a sustainable inflation rate of 2 percent had grown, and the Fed’s other mandate, employment, would take center stage.
Yield on 10-year government bonds
The chart shows that the bond market had expected the development, as the yield on 10-year government bonds fell from 4.28% at the end of July to just under 3.80% on Friday (August 23).rd), a total downward move of 48 basis points (0.48 percentage points). Since the Fed views a 2.75% benchmark interest rate as “neutral,” we expect the 10-year Treasury yield to decline by at least another 100 basis points (a full percentage point) by mid-2025, or sooner, depending on upcoming economic data.
Some economic observations
Previous blogs have claimed that the Fed is “lagging behind” when it comes to rate cuts. This is because of the long lags between a change in monetary policy and its impact on the economy. Delinquencies are always the first sign of trouble. The charts show the rising trend of delinquencies by age group for credit cards and auto loans. The dotted lines show that delinquencies for some age groups are approaching their peaks during the Great Recession!
Transition to severe delinquency on credit cards by age (left) and auto loans by age (right)
It is also worth noting that the growth rate of consumption, as indicated by retail sales (+1.0% in July), has far exceeded income growth, resulting in lower savings. The savings rate is in the mid-3% range, while before the pandemic it was above 8%. It cannot go much lower. As more consumers max out their credit cards and delinquency rates continue to rise, the inevitable result will be a significant drop in spending. This impacts retail, leading to layoffs that further reduce incomes (a vicious cycle). Banks are currently struggling with rising loan defaults, and rising unemployment will only exacerbate the situation. Rising defaults are a clear sign of impending trouble.
Leading indicators
The Conference Board’s Leading Economic Indicators (LEI) fell again in July (-0.6%). This index is now 15.3% below its peak. The chart from the 1960s shows that 100% of the times the LEI has fallen that much, there has been a recession.
Leading indicators
Commercial real estate
The next chart shows the default rates for all Commercial Mortgage Backed Securities (CMBS
iShares CMBS ETF
Office loans fall into arrears
Final thoughts
Financial markets reacted positively to Fed Chairman Powell’s speech at the Jackson Hole Symposium. Powell expressed high confidence that inflation will be brought under control and said the Fed will cut rates now as concerns grow about a labor market that, while still relatively healthy, is weakening. Therefore, the Fed will cut rates toward its “neutral” zone (2.75% in the Fed’s view). The two remaining questions are: 1) How fast will rates rise? and 2) Will the Fed cut them fast enough to avoid a recession (or is it already too late)?
The massive revision to the Nonfarm Payroll Establishment Survey data (-818,000) certainly played a role in Powell’s deliberations. Much of the overcount is likely due to the blind (automatic) addition of 75,000 to 125,000 jobs per month via the small business birth/death model. Given this built-in bias, markets and investors should pay more attention to the household survey, which has been signaling an easing labor market for several months. The loss of about -500,000 full-time jobs should be a clear indication of the health of the labor market.
Other economic indicators continue to point to a slowdown in the economy. The regional Federal Reserve Banks of Atlanta, New York and St. Louis recently significantly lowered their third-quarter GDP growth rates. Delinquencies on credit cards and auto loans, signs of an exhausted consumer, are now approaching Great Recession highs. This, along with rising delinquencies and defaults on commercial real estate, spell trouble for lenders in this area. And of course, exhausted consumers (70% of GDP) cannot continue to spend faster than their incomes are growing. And while a recession has not officially arrived yet, the huge downward revisions in employment numbers as well as the decline in the Conference Board’s leading economic indicators give us cause for recession fear.
Our months-old forecast of lower interest rates finally seems to be coming true. In such an environment, longer-term and high-quality bonds will benefit.
(Joshua Barone and Eugene Hoover contributed to this blog.)
