Here We Go Again

It was just a month ago when weak nonfarm payroll data was released and markets swooned. It wasn’t the only reason; the unwind of the Yen carry trade also had an impact, but the nonfarm payrolls (NFP) number rekindled growth concerns, albeit briefly.

Since then Fed Chair Powell has shifted the Fed’s focus to the labor market while effectively confirming a first interest rate cut later this month. Powell stated plainly, “We do not seek or welcome further cooling in labor market conditions”, making the NFP data point a primary focus for both the stock and bond markets.

Flash forward to Friday and once again, the NFP data is moving markets. The August data, which is shown below, was a mixed bag. Payrolls were below expectations, but better than the July report and the unemployment rate ticked down. The ugly July report was also revised down to 89,000. Expectations were that 165,000 jobs were created in August, but the actual report was weaker at 142,000, but better than the 114,00 initially reported a month ago.

For some perspective, we believe NFP prints need to start moving below the 100,000 level before economic worries get really serious. The stock market appeared to be more spooked by the revision of the July data and tumbled badly on Friday. We aren’t as concerned. At this point, the 89,000 data point it appears to be an anomaly and slower growth is not only acceptable, it is a necessary ingredient in a soft landing. A rapidly slowing economy is not desirable because it would be indicative of a more serious economic problems about to happen. The stock market remains optimistic, but it has low tolerance for poor data, as evidenced on Friday. The bond market, on the other hand, has been quicker to embrace declining growth and has probably rallied about as far as it can without further economic weakness being reported.

Un-Inversion

It was about 2 years ago that the yield curve inverted (long term rates lower than short term rates) and kicked off the most anticipated recession in history – which never happened, at least not yet. Fixed income investors normally require higher yields for longer terms because the risk of inflation is greater over longer periods of time. An inversion is therefore an abnormal event. The yield curve must un-invert at some point whether we have a hard or a soft landing.

Un-inversion was reached this week when the 10-year treasury yield popped back above the 2 year treasury yield. Why does that matter, you ask? Well, it may not matter at all, but in recent history, recessions did not begin until the yield curve un-inverted. Translation: this is where the rubber meets the road. After two years of speculation, the moment of truth is on its way.

There is nothing in the data that screams for an aggressive Fed rate cut at their next meeting in two weeks. Payroll additions of roughly 150,000 per month are relatively healthy. The economy has some headwinds, but there is nothing obvious that is indicating an impending recession. That argues for a quarter point rate cut in two weeks.

The stock market decline on Friday seems to be screaming the opposite. They want a half point cut and they want it now. The bond market is in agreement as rates are modestly declining on the NFP news. On Friday afternoon the bond market had priced in 100 basis points in cuts by year end, and 250 basis points in cuts by year end 2025 (a basis point is 1/100 of a percent). If that were to become reality, the Fed Funds rate would drop from the current range of 5.25-5.50% to 1.75%-2.00% by the end of 2025. That doesn’t sound like a soft landing

The outcome is far from clear. There are plenty of good arguments on both sides of the recession debate. The Fed will give us hint as to what they expect in two weeks. If the Fed cuts a ‘normal’ 25 basis points, as we would expect, it implies that the Fed believes it remains on track for a soft landing. (The Fed is rarely swayed by a petulant stock market.) A 50 basis point cut feeds into the current mood of markets and could ignite fears that the Fed is admitting it has waited too long to begin cutting rates.

We’ll be watching nonfarm payrolls (NFP) very closely to see if they fall, and stay, below 100,00 each month. If they do, the economy is probably in some trouble. If NFP stays above 100,000, a soft landing has probably been achieved.

Have a great week!

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 The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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By: Adam