The last week of data offered some turbulence across economic indicators and market signals that brought the word “recession” back into the mix. Investors have been digesting softer payrolls, higher unemployment, heighted foreign exchange volatility, falling government bond yields, rising rate cut expectations, a small cap equity correction, and several household mega cap stocks down more than 10%. That was the story at the end of the day on August 5th. At the time of writing this, just over twenty-four hours later, volatility had come down slightly across FX, Treasuries, and equities. Government bond yields are up in the U.S., Germany, U.K., Canada, and Australia, while the NASDAQ, S&P 500, and Russell 2000 are up over the last day and a half, but rate cut expectations have not budged implying 50-basis-point rate cuts at the FOMC’s September, November, and January meetings. Taking a step back from all the noise, we will review the labor data and market dynamics over the last few days.
Nonfarm payrolls grew by 114,000 in July, below the 179,000 print in the prior month. On a y/y basis, total payrolls slowed to 1.6%, its fourth sequential deceleration in a row. This is in-line with the same trend we have observed for the last eighteen months as the pace of hiring has moved below the elevated levels seen in the pandemic recovery period.
Source: Macrobond.
Underneath the headline, it is worth noting the recent change in growth between the private sector and government sector as a percent of total nonfarm payroll growth. In July, the private sector accounted for 85% of m/m payroll growth and the government sector accounted for the remaining 15%. In 2023, the private sector averaged 76% of m/m payroll growth and the government sector averaged 24%. On a year-to-date basis, the average for the private sector has increased to 84%, while government has decreased to 16%. Another callout from this release was the rise in full-time employment to start the third quarter, following the acceleration in the second quarter. These payroll dynamics will be important to watch going into 2025 as we look for signs of a reacceleration or deterioration in private sector activity.
Source: Macrobond.
In addition to slower payroll growth, the unemployment rate ticked up to 4.3% from 4.1%, its fourth month in a row increasing. However, the number of people reported as unemployed due to bad weather rose to 461,000, the most on record compared to any other July. At the same time, the labor force participation rate increased to 62.7 and prime age workers saw an increase from 83.7 to 84.0, its highest level since the first quarter of 2001. On net, we believe the latest release was more of a mixed bag than what headline news and subsequent trading days would suggest. While a meaningful rise in unemployment would lead to a shift in our view, the current corporate earnings setup (outside of some large cap Tech and Discretionary companies) does not reflect previous environments where mass layoffs occurred.
Source: Macrobond.
Without diving into all of the market data, some of the key signals we have been watching have started to reverse the move from Friday and Monday. The first chart below provides a snapshot of 10-year government bond yields from the U.S., Germany, U.K., Canada, and Australia. The second chart highlights movements in the U.S. Dollar Index (DXY) and two major developed market currency pairs, USD versus the Japanese Yen and USD versus the Euro. The third chart shows the VIX, a commonly used measure of S&P 500 volatility, which has moved back below 25 from 56 at the start of Monday. In our view, the way the last few days have traded is likely largely due to rising volatility that can cause a reversal in levered positions that induce further volatility and selling.
Source: Koyfin.
On the monetary policy front, the market’s expectations for rate cuts increased meaningfully over the last week. The following charts show the changes in expected policy rates by meeting date for the U.S., Euro Area, U.K., Canada, and Australia. While the base effect setup for growth and inflation data through August and September increases the probability of a rate cut in September from the FOMC, we will be waiting to see if the inflation dynamic changes in the fourth quarter and into 2025, making it more difficult to continue cutting rates at a pace the market currently expects. With inflation above target and a rising probability of reaccelerating by yearend, GDP around 2.5%, and equity indexes still near all-time highs, it would be an unusual environment for 50-basis-point rate cuts at consecutive meetings through January.
Source: Bloomberg.
In between economic releases and FOMC meetings, we will continue to track the market-based signals highlighted above alongside key commodity prices for insight into the path of inflation and likely outcomes across major country policy rates.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Investment Strategist
Boyd Watterson Asset Management, LLC