Payrolls Boost Rate Cut Expectations
A week is a long time in politics, but it can feel like an eternity in financial markets. In our recent piece, "The Mirage of Western Prosperity" (Markets - EPIC Investment Partners (epicip.com) we highlighted the concerning debt levels of G7 nations, concluding that the question wasn't if interest rates would fall, but how far and how fast. Recent events have provided a resounding answer.
The precipitous drop in global bond yields, notably a 45 basis point decline in the US 10-year since our daily, can be partly attributed to Federal Reserve Chair Powell's hints that payroll data might be overstating job growth, suggesting a September rate cut is on the horizon.
Today's payroll figures further solidified this expectation, with the headline number falling well short of forecasts (114k versus expectations of 175k). Crucially, the unemployment rate has risen to 4.3% from its low of 3.4% in January last year. Models like the McKelvey Rule and Sahm Rule, which use changes in unemployment to predict recessions, are flashing warning signs. Adding to the unease, Intel's announcement of a 15,000-person workforce reduction suggests trouble brewing within certain US companies.
However, jobs aren't the sole driver of this rapid shift in interest rate expectations. The US ISM manufacturing survey, while indicating contraction, isn't new news, as the survey has shown contraction for 20 of the past 21 months. What is noteworthy is the sharp decline in household expectations of future income. Last week, the University of Michigan's Consumer Confidence report, while weaker than last month, masked a concerning trend buried within its data. A survey question on expected income changes has seen one of its sharpest declines ever, suggesting that people are bracing for reduced incomes or job losses. This implies weaker demand going forward, which in turn could lead to more job cuts, creating a potentially vicious cycle. Watch for larger rises in the unemployment rate going forward.
This raises questions about the seemingly strong job gains in recent payroll data. It's important to remember that payroll figures measure the number of jobs, not individuals employed, and incorporate a statistical adjustment called the birth/death model. This model, based on historical data, can overestimate job creation, particularly at economic turning points. Therefore, the unemployment rate provides a more reliable picture of the labour market's true state.
Today's payroll data and the further rise in the unemployment rate reinforce our earlier assertion: the question isn't if interest rates will fall, but how far and how fast. Moreover, today's figures raise the alarming possibility that we may already be in the midst of a recession.
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