A Short History of Rate Cuts

The Days Ahead:

• Short week, with company earnings starting in earnest.

This Week:

• The job numbers aren’t as strong as they look.
• Response rates are way down.
• And education jobs still aren’t at pre-Covid-19 levels.
• Investors expect rate cuts this year.
• But there won’t be as many as people think.
• We look at the history of rate cuts.
• Bitcoin goes mainstream.

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Those Jobs Numbers

Last week’s jobs numbers were quite a bit better than expected, coming in at 216,000 compared to 136,000 in November and an estimate of 160,000.

Boom! Went the algos. The U.S. dollar strengthened, the 10-year U.S. Treasury yield climbed from 4.0% to 4.1% (about a 2% fall in price) and stocks sold off. That was all because the number was higher than expected and investors assumed the Fed would defer rate cuts. But by Monday, it was like the payroll number never happened. Stocks were up, the dollar weaker and the 10-year Treasury was back to where it was on Thursday.

Why the reversal? Well, it comes down to three things.

First, the margin of error on new payrolls is huge, as much as +/- 130,000. So, no estimate can hit the number dead on. Also, the Bureau of Labor Statistics (BLS) changed the numbers for the prior two months. The October and November numbers were revised down by 71,000 from 349,000 to 278,000, which is a 25% swing. Revisions are typically made as more data comes in or as seasonal adjustment factors change.

Why would seasonal factors change? Well, take holiday shopping. Many years ago, sales would have spiked in the three weeks leading up to the late December holiday. Then promotions started earlier and earlier and now holiday sales start at Halloween. The total spend may not have changed but the sales are spread over two months. It’s the same with employment. The seasonal adjustments are playing catch-up with changing employer and consumer behavior. Different hiring patterns make seasonal adjustments harder, especially so since Covid-19.

Seasonal revisions aren’t the only problem. In September 2008, just as the financial world was about to crater, the BLS reported job losses at 159,000. A year later they were finally tallied at 403,000. The October 2008 losses were initially reported as 240,000 but later revised to 423,000. What looked like a manageable two-month job loss of 400,000 turned out to be 826,000. The problem back then was businesses were slow to respond to the surveys. In the initial report, around 73% of companies responded. Two months later the response rate had climbed to 95%. It turned out that employers with the biggest job losses weren’t getting back to the BLS in time. Which is fair enough. After all, if you’re dealing with a recession, you may push a government questionnaire to the bottom of your to-do list.

Second, the response rates to the survey were low. Here it gets a bit confusing because the jobs report is made up of two surveys. One is the household report, where the BLS calls up around 60,000 people and gets a response rate of around 71%, down from 80% a few years ago. That’s where we get the unemployment numbers, participation rates and information on the self-employed. According to this report there are 161.1 million people working in the U.S.

The other is the establishment survey, where the BLS calls up 660,000 worksites and asks how many people are working at that office, retail outlet, hospital or any other “establishment”. According to this report, there are 157.2 million people working in the U.S. The 4 million difference between the two is made up of sole proprietors, self-employed or people who may be between jobs. This establishment survey normally has a response rate of around 65% for the first go-around but 95% by the time the third revision is published.

But not in December 2023. The response rate was only 49% which is the second lowest it’s been in 35 years.

A low response rate means a low confidence rate, so the 216,000 new jobs seems too high.

We’d also point to the household survey where 680,000 people left employment according to the report. This reverses the climb of 585,000 in November. So, we have to ask ourselves, why would 585,000 people come into the workforce in November and 682,000 leave four weeks later? Unless there was a mass retirement or people just couldn’t find jobs and took themselves out of the market for a few weeks? None of those seem plausible.

So, the puzzle remains. We saw a lot of people coming into the workforce but that’s from a survey which only received a 49% response rate. And we saw a lot of people leaving the workforce based on a response rate that is falling and likely even lower than the 71% it last reported in October. Those two are difficult to reconcile! We’re very sure that the headline number of 216,000 will almost certainly be revised lower.

Finally, we looked at the type of jobs created over the last few months.

We took the regular jobs report and excluded education, healthcare and temporary jobs. There are around 14.4 million education jobs in the U.S. or around 9% of the workforce. Some 11 million are in state and local government with the rest in private schools, colleges and universities. The biggest component is local government education jobs, which are at 8 million and still below their pre-Covid-19 peak. If the pre-Covid-19 trend had remained in place, there should be more than 8.4 million jobs. In other words, the education jobs are not keeping up with population growth. Local governments are hiring very slowly.

It’s much the same for healthcare, which was another sector that saw a big decline during Covid-19-19 and has been very slow to recover. Both job categories are driven more by demographics than the business cycle. They matter, of course, because the bring more spending into the economy but we’re trying to understand the underlying growth in jobs and put aside replacement hiring. There the picture is quite weak. The blue bars, in the graph, show a steady fall in new jobs and the three-month average, in green, has fallen steadily since the Fed started raising rates early in 2022.

None of this suggests that the jobs market is in trouble. But it’s not as strong as it looks and it’s unlikely the Fed will concern itself with the headline level. We’ll know more in the next few months but to us it looks like the Fed’s 5.25% increase in rates is beginning to show up in increasingly slower employment growth.

When Rate Cuts Come

By this stage we know that rate cuts are likely to come in 2024. If the Fed sees inflation heading down and the economy slowing down, then it’s likely they’ll start cutting. One question is by how much?

The average career of a trader is around 10 years. After that you’re ready to move on. The stress will probably have got to you or you’ve lost your edge, mind or a lot of money. So, the market only really has experience of cuts from the 2000 and 2007 recessions. Both of those were quick cuts to near zero, with big declines in growth and employment. Both were scary times.

But that’s not what’s going on in 2024.

In January of 2001, we saw the Fed cut rates by 0.50% to 6.00%. In the next 10 meetings, they dropped to 1.75% by December 2001.  Pretty fast.

In September 2007, we saw the Fed drop rates by 0.50% to 4.75% and in the next nine meetings to December 2008, to 0.25%. So, in 10 meetings over 15 months, the Fed went from 5.25% to 0.25%. Again, pretty fast.

But if we look a little further back, when a lot of today’s traders were probably not around, it’s a different story.

Here’s a chart of the fed funds rate going back to the mid-1950s. There are two lines because up until 1970, there was no announced “target” fed funds rate, just a market rate that the Fed managed…hence the two lines.

The last 20 years stick out as very unusual. Each easing period was quick, followed by a long period of low or gradually rising rates. We’ll exclude 2020 because the Covid-19 era is not your average recession.

From 1956 to 2007, there were 16 easing cycles. The average time from first to last easing was 12 months and ranged from just three months in 1971 to 41 months from June 1989 to September 1992. The average decline was 4.70% and if we exclude the early 1980s cuts, when rates were a freakish high of nearly 20%, the average decline was 3.80%.

If we look at all the easing cycles since 1956, we see this:

The way to read this is that in, say, 1998 in the top left, the cuts were only 0.75% and were done in four months. Inflation was low and unemployment steady. The Fed was just helping out a liquidity problem caused by a spectacular implosion of a hedge fund. It was the classic “pre-emptive” cut so there was no need to do more.

On the other extreme, in 1981, the Fed cut rates by over 10%. But GDP was then running at 8% and inflation at 13%. It was time to cut quickly. By the end of 1982, inflation was down to 5%.

So, we have fewer and gradual cuts (in the top left and highlighted area) to more and faster cuts, like 1980 and 1981 down at the bottom. The easing cycle in 1989 is an obvious outlier. That was a period of extended growth and inflation falling from over 5% to 2%. The Fed took its time to cut over a three-and-a-half-years.

What will happen this time? If we look at the fed funds futures, we see the market expects cuts of around 1.50% in the next 11 months. If we use the Fed’s estimates, we see cuts of around 0.75%. We think the Fed is the one to go for here and that means the rate cut cycle is likely to look like the ones in the top left of the chart: over a period of 6 to 10 months and about 0.75% to 1.00%.

Today the market seems confident that the cuts will be many and come quickly. But it’s more likely that they’ll be few and arrive slow. The economy is in good shape. No need for a repeat of 2000 or 2007.

X and the Bitcoin ETF

The SEC announced its approval of a Bitcoin ETF on Tuesday, but, whoops, it was from from a fake account on X/Twitter. The SEC Chair, Gary Gensler has to use his personal account to say, no, it was someone front running the approval.

The result was a 15% swing in the price of Bitcoin in two days.

The next day, the SEC approved several funds, which are technically exchange traded products (ETPs) not ETFs. Several funds were launched from heavyweights like BlackRock, and Invesco, as well as niche players like Valkyrie.

This was not an auspicious start to mainstream Bitcoin. Even the SEC’s statement was a bit odd because it used the word “approval”. As any prospectus will tell you, the SEC doesn’t approve or disapprove anything. They just allow fund registrations.

Look, Bitcoin and crypto are specialized spaces. We’re not going to get into the whole blockchain, fiat money, or anonymity claims except to say that there’s been a ton of fraud around crypto. The SEC approval will probably help Bitcoin’s reputation but it’s undoubtedly a very speculative and volatile investment. On Thursday, the price climbed 10% and promptly fell 10%. The price peaked in November 2021 and was down 75% at one point before recovering 187%. That sounds good except you need a 400% return to recover a 75% loss.

We’d just ask if you’re considering an investment in any Bitcoin ETF, that you check with your Cerity Partners’ financial advisor first. Please.

The Bottom Line

The main news of the week was the inflation report on Thursday which was slightly ahead of expectations at 0.2% at 0.3% On an “unadjusted” basis, which is before the seasonal adjustments, prices actually fell 0.1%. The annual rate was 3.4% compared to 3.1% for November. There were some stand out items like car insurance, which is up 20% in the last year. We discussed this last July. It’s basically comes down to the high cost of Electric Vehicle repairs and their higher speeds and acceleration.

The rent and home ownership price index is up 6.3% but should come down as new rents, which are falling, come into the index calculations.

The yield on the 10-year Treasury was unchanged at around 4.05%. We think it got ahead of itself in December when it reached 3.78%. It should settle in at current rates, at least until the Fed meets at the end of the month.

The S&P 500 had a bumpy start to the year last week but this week climbed around 1.8%. Earnings season starts today.

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Art of the Week: Frances Bell (b. 1983)