Last week brought the last big package of labor market data the Federal Reserve (Fed) will have at its disposal while it considers the pace and timing of a policy easing cycle it has made clear will be starting at next week’s Federal Open Market Committee meeting.

More Evidence of a Labor Market Slowdown

  • The first release was the Job Openings and Labor Turnover Survey data for the month of July, which showed job openings down to 7.7 million, which translates to an openings rate of 4.6%. This reading was below consensus of 8.1 million and last month’s 7.9 million. Job openings continue to fall after peaking at 12 million in 2022, as employers pull back on demand for labor after a massive hiring surge post-COVID. Openings fell in health care and social assistance, state and local government, and transportation, warehousing, and utilities, while professional and business services saw the largest increase of job openings, which had been particularly weak in the June report. The hiring rate was up slightly to 3.5%, but the quits rate was unchanged at 2.3%, which reflects employees sensing that cooling labor markets are limiting their ability to upgrade their employment. Consistent with other data sets, the layoffs and discharges rate remained very low at 1.2%.
  • The next day came the ADP National Employment Report, which showed job gains of 99,000, which was below estimates of 141,000 and last month’s reading of 111,000. This series tends to offer clues into the all-important payroll data that is released later in the week, although the two series have diverged and sent mixed messages in the past. Initial jobless claims came in at 227,000, which was below estimates and a tick down from the week prior. Continuing claims revealed a similar story at 1.838 million versus estimates of 1.868 million, down from last week’s 1.860 million.
  • Last, but certainly not least, Friday’s Bureau of Labor Statistics’ household survey showed nonfarm payroll gains for the month at 142,000, below consensus estimates for 160,000. Payroll numbers were also revised down for the two previous months, with June payrolls revised down by 61,000 to 118,000 and July payrolls down by 25,000 to 89,000. Job gains in August were driven by health care, leisure and hospitality, government, and construction industries, while net job losses were seen in manufacturing, retail trade, information, and temporary help services. Incorporating revisions, the three-month average of 116,000 new jobs is still above the 21st-century average of 95,000, but it is also the lowest level since the depths of the COVID-19 crisis.
  • The household survey saw the unemployment rate tick down from 4.3% to 4.2%, as expected. Driving the downward move was a reversal in temporary layoffs. This category (which includes employees who were recently furloughed and either have been given a return date or expect to return to the same job within six months) had jumped in July, possibly due to weather or idiosyncratic-industry disruptions (e.g., autos). The cohort of those who have lost their jobs permanently (which typically drives unemployment increases during recessions) was effectively unchanged, although the respondents who completed temporary work and are having trouble finding the next position ticked up slightly. Taking a step back, a 4.2% unemployment rate still falls in the upper quarter of the country’s history since 1948, well below the average of 5.7%.

Productivity Gains Help Wage Growth Outpace Inflation

  • One area where revisions were good news was in second quarter (Q2) productivity data. The final estimate for Q2 productivity was revised up from 2.3% annualized to 2.5%, which led to unit labor costs (which adjust wage costs for changes in productivity) being revised down from 0.9% to just 0.4% annualized in Q2. Looking forward, productivity gains will continue to be the link that allows for wage growth to outpace overall inflation. This is evident as average hourly earnings came in at 3.8% in August, while the Consumer Price Index (CPI) is expected to be 2.6%. Over time, we expect investment in artificial intelligence and automation to drive a structural increase in productivity, which has been particularly sluggish in the post-Great Recession period.

Services Sector Continues to Be More Resilient Than Manufacturing

  • Moving away from labor markets, the week’s ISM surveys provided more of the same, painting a picture of a languishing manufacturing sector but an impressively resilient services sector. The ISM manufacturing index came in at 47.2, slightly below the 47.5 estimate and continuing the contractionary theme that has been pervasive in the goods economy since 2022. Meanwhile, the ISM services index came in at 51.5, ahead of the 51.1 estimate. Even as rate-sensitive sectors like manufacturing and housing have been stuck in their rolling recessions, the services economy is still proving to be strong enough—and large enough—to power consumption and keep overall economic growth near its long-term trend.

A Jumbo Cut Not Entirely Out of the Picture

  • The week’s package of labor data (and revisions to prior data) increased chatter that the Fed will begin its campaign of policy normalization this month with a rate cut of 50 basis points (bps). Speeches by Fed governors John Williams and Christopher Waller on Friday seemed to indicate that 25 bps remains their base case. But neither governor took the opportunity to completely shoot down the idea of a jumbo cut to start the cycle, nor did Fed Chair Jerome Powell in his comments in Jackson Hole a few weeks back. As of last Friday, fed funds futures markets were pricing in about a 70% chance of a 25-bps cut and 30% chance of 50-bps cut.

Yields Fall Hard Amid an Uncertain Economic Outlook

  • Yields fell hard last week as investors grapple with the outlook for economic conditions and monetary policy. The 10-year U.S. Treasury fell to 3.72%, the lowest level since mid-2023 when yields were on their way up to 5%. The 2-year U.S. Treasury fell to 3.66%, which was good for a slight “un-inversion” of the yield curve, at least as defined by the 2-year to 10-year spread. Looking forward, the spread between the effective federal funds rate and the 2-year Treasury is reaching historic levels and reflects aggressive expectations for policy easing that might be more appropriate for an outright recession than the soft landing we are still expecting.

Equity Markets Paying Closer Attention to Growth Indicators

  • The stock market has shifted its focus on when the Fed will cut interest rates to why the Fed will cut interest rates. The concern is that U.S. economic growth is slowing too rapidly and that the Fed is behind in cutting rates. Particular attention is being paid to the labor market. Thus, in the week ahead, we should expect equity markets to pay more attention to macroeconomic indications concerning growth (e.g., weekly jobless claims, consumer sentiment) than to those concerning inflation (CPI, Producer Price Index). This is a distinct shift from the past three years. Inflation is clearly coming down and that trajectory risks bringing a recession back into the forecast. Equity markets’ response to this debate needs to be framed in the context of September, which, as we discussed last week, is a highly volatile and often negative month. It is also just one random collection of 30 days within a 365-day year.
  • We continue to place a low probability on a recession (25%). Therefore, we are continuing to maintain our tactical overweight positions to the equal-weighted S&P 500 Index and the small- and medium-cap sector. These two trades have been back-and-forth all year in terms of relative performance. They seem to act as a referendum on the soft landing versus recession debate.

Source: FactSet

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