Jobs Revised Away – A Dovish Fed – A Slowing Economy = Lower Interest Rates

For several weeks, the financial markets have been looking forward to Fed Chair Powell’s Jackson Hole speech, hoping they would glean some perspective on what lies ahead for interest rates. More anxiety occurred on Wednesday when Nonfarm Payrolls (Jobs) were revised sharply downward by -818K (see below). To show the angst in the equity space, as of the close of business on Thursday (August 22^nd), the major averages were flat for the week (table’s middle column).

On Friday, when the normally hawkish Chair Powell gave a dovish speech, markets celebrated, especially 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 informs us that:

• The Dow Jones closed just off its all-time high of 41,191.08 set on July 17^th (far right column).
• The S&P 500 is also inches away from another record high (5667.20).
• The tech heavy Nasdaq, while up for the week, is still off more than -4% from its July 10^th peak, indicating that the enthusiasm for tech stocks is fading.
• A look at the next table (the Magnificent 7) shows why the tech heavy Nasdaq is lagging and is more than -4% away from its record high. Note that Nvidia (NVDA) is the only one of the seven to close at a new high on Friday, while the likes of MSFT, AMZN, TSLA, and GOOG are still down double digits from their July peaks. A simple average for all seven indicates that they are still nearly -8% below those July peaks. Clearly, market sentiment has shifted away from “tech.”

What Happened to Those Jobs?

Prior to Powell’s speech, and, perhaps, a large influence on it, on Wednesday, August 21^st, the Bureau of Labor Statistics (BLS) announced that they had revised the Nonfarm Payroll jobs numbers down by -818,000 for the one-year period ending in March 2024. This is a -28% decline in the number of jobs created over that 12-month period, reducing the monthly job gains by a significant -68,000 per month. This was the largest downward revision for any year since 2009 during the Great Recession. It should also be noted that a downward revision of -306,000 jobs occurred last August for the April 2022 to March 2023 period.

Why such large revisions in the last two years? The most likely culprit is the Birth/Death model add-on. One might ask: “What’s the Birth/Death model and what is the rationale for including it in the monthly jobs’ calculations?”

The monthly Nonfarm Payroll number comes from a monthly survey of large and medium sized businesses. In the 1990s, pressure was brought such that small businesses, thought to be the heart and soul of the American business landscape, ought to be included. So, the folks at BLS collected data and built 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 that trend number (seasonally adjusted) every month to their survey of large and medium sized businesses. It amounts to somewhere between 75,000 and 125,000 jobs per month. It is just an extended trend-line and, to the detriment of the survey, it is not influenced by current economic conditions.

Of course, there is market data that gives us a clue as to the health of small businesses, like the level of business bankruptcies which, currently, have risen +52% from a year earlier and are now nearing 10-year highs, or the number of new business formations which are down -11.5% year over year. That data should, but doesn’t, have an influence on the Birth/Death add-on.

On a monthly basis, when BLS does its employment survey of large and medium sized businesses, it also does a survey of households regarding employment. This is called the Household Survey, and it is used to calculate the unemployment rate. The fact that the unemployment rate has risen from 3.4% in April 2023 to 4.3% this past July is another indicator that the labor market is not as strong as generally thought. In addition, there have been other indicators showing a cooling labor market, such as BLS’s monthly Job Openings and Labor Turnover Survey (JOLTS) which has shown a rapid cooling in job openings, a lengthening of time to find a new job once an employee is laid off, and a rising number of layoffs as documented monthly by the employment firm of Challenger Gray and Christmas.

Jobs, of course, are a key metric in assessing the health of the economy. As noted above, Fed Chair Powell has now confirmed that the Fed will begin reducing rates at its September meeting. At this writing, markets think a 25-basis point reduction is a sure bet with a 50-basis point reduction now at 33% odds. There are several key data releases between now and the Fed’s September meeting which will surely play a role in its rate setting decision (whether 25 or 50 basis points) including the August jobs reports, a JOLTS, and the PPI and CPI releases.

The Fed

A reading of the Fed minutes from its July meeting, released on Wednesday, indicated that a rate reduction was discussed, and the minutes were considered by Fed Watchers to have been the most dovish in quite a while, at least since 2021. So, Powell was expected to prepare markets for rate reductions at the Jackson Hole Fed Symposium (Reassessing the Effectiveness and Transmission of Monetary Policy). And that’s exactly what he did, i.e., he laid the groundwork for a major move in interest rates back toward the Fed’s “neutral” level (2.75%). In his speech, he said that the time for rate cuts had arrived, that his confidence that inflation is in a sustainable path to two percent had grown, and that the other Fed mandate, employment, would move into the spotlight.

The chart shows that the bond market had anticipated the move with the 10-Year Treasury yield falling from 4.28% in late July to just under 3.80% on Friday (August 23^rd), a total downward move of 48 basis points (0.48 percentage points). Because the Fed sees “neutral” as a Fed Funds Rate of 2.75%, we expect to see the 10-Year Treasury yield fall at least another 100 basis points (a full percentage point) by mid-2025, or sooner, depending on incoming economic data.

Some Economic Observations

Past blogs have maintained that the Fed is “behind the curve” when it comes to rate reductions. That’s 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 for some age groups, delinquencies are nearing their Great Recession peaks!

It is also noteworthy that the growth rate in consumption, as indicated by Retail Sales (+1.0% in July) has far outstripped the growth in income, and that has led to a lowering of savings. The savings rate is in the mid 3% range while it was above 8% pre-pandemic. It can’t go very much lower. As more consumers max out their credit cards, and as delinquency rates continue to rise, the inevitable result will be a significant spending slowdown. That impacts retailers which leads to layoffs which further lowers income (a vicious cycle). Banks are currently facing rising loan delinquencies, and rising unemployment will only exacerbate the situation. Rising delinquencies are a clear sign of trouble ahead.

Leading Indicators

The Conference Board’s Leading Economic Indicators (LEI) fell again in July (-0.6%). That index is now down -15.3% from its peak. The chart, dating back to the 1960s, shows that, 100% of the time, when LEI have fallen this much, a Recession occurs.

Commercial Real Estate

The next chart shows delinquency rates for all Commercial Mortgage Backed Securities (CMBS
iShares CMBS ETF
) – the white line – and for Office Buildings – blue line. Both started rising in 2023. Because of the capability to work from home, spurred by the pandemic, office buildings are now suffering high vacancy rates. This is going to bite investors and Regional and Community banks.

Final Thoughts

The financial markets reacted positively to Chairman Powell’s address at the Fed’s Jackson Hole Symposium. Powell expressed high confidence that inflation was coming under control and said the Fed would now move interest rates lower as concern is growing over a labor market that, while still relatively healthy, is trending weaker. Thus, the Fed will be moving rates toward their “neutral” zone (2.75% in the Fed’s view). The two remaining questions are: 1) How fast will rates move; and 2) Will the Fed move them fast enough to avoid Recession (or is it already too late)?

The huge revision in Nonfarm Payroll Establishment Survey data (-818K) certainly played a role in Powell’s thinking. Much of the overcount likely came from the blind (automatic) add-on of 75,000 to 125,000 jobs per month via the Birth/Death model for small businesses. Given that built-in bias, markets and investors should pay more attention to the Household Survey which has been signaling a labor market easing for several months. The loss of approximately -500K full-time jobs should be a strong clue as to the labor market’s health.

Other economic indicators continue to point to a slowing economy. The Regional Federal Reserve Banks of Atlanta, New York, and St. Louis have, of late, been significantly lowering their Q3 GDP growth rates. Credit card and auto loan delinquencies, signs of an exhausted consumer, are now approaching the peaks seen in the Great Recession. This, along with rising Commercial Real Estate delinquencies and defaults spell trouble ahead for the lenders in this space. And, of course, tapped out consumers (70% of GDP) can’t continue to spend faster than their incomes grow. And while a Recession has not yet officially arrived, the huge downward revisions to the jobs’ numbers along with the fall in the Conference Board’s Leading Economic Indicators give us Recession anxiety.

Our months old forecast for lower interest rates finally appears to be coming to fruition. In such an environment, longer maturity, high quality bonds will benefit.

(Joshua Barone and Eugene Hoover contributed to this blog.)