Capital markets perspective: Right down the middle
Capital markets perspective: Right down the middle
Capital markets perspective: Right down the middle
09.09.2024
I’m not much of a golfer, but I know this much — it’s usually way better to hit the ball down the middle of the fairway than it is to hit it too far to the left or too far to the right. But last week taught me something new: Sometimes, “right down the middle” can be a bad thing, like when summarizing a non-farm payrolls report late in an expansion cycle.
Here’s the thing: Friday’s labor situation report (aka “non-farm payrolls,” aka “The Big Burrito”) wasn’t all that bad. It was a little light of economists’ expectations, but the U.S. economy still added 142,000 new jobs last month, and the unemployment rate ticked one-tenth of a percent lower to 4.2%.1 The word “unchanged” was used so often inside the release that it made me think I was reading a smuggled copy of “Marketing the NFL in 2024: Taylor Still Loves Travis” rather than the Bureau of Labor Statistics’ most popular product.
And yet equity markets still hated it: Friday ranked among the worst days so far this year for U.S. large-cap stocks, and depending on how you count it, last week was the worst week so far this year for big benchmarks like the S&P 500® Index and the Nasdaq Composite Index. The selling had a decidedly risk-off feel to it, too: sectors like consumer staples, utilities, and real estate were able post small gains, but just about every other sector was lower on the week — especially high-growth sectors like technology and telecom.
It didn’t help that chipmaker Nvidia, which has become a virtual stand-in for all things artificial intelligence (AI) (and consequently a HUGE portion of most U.S. large-cap stock indexes), dropped again and saw its hypnotic powers continue to fade. But that’s nothing new: Nvidia began to lose its power to captivate a week and a half earlier after its second-quarter earnings release failed to inspire new robot dreams among the investing public, and yet the market was mostly unable to sidestep deeper damage. Not so last week. So while it might be convenient to blame Nvidia and its peers for last week’s volatility, you have to look a little beyond the wilting of the AI rose to explain it.
My take? It’s because Friday’s non-farm payrolls data was right down the middle: not strong enough to fully support the “soft landing” thesis but also not weak enough to convince anyone that the Federal Reserve (the Fed) might be tempted to super-size its widely expected rate cut to 0.50% when it meets next week. Ironically, things might have ended up better for markets if the labor market had instead sliced its shot into the weeds on the right side of the fairway or hooked it left into the pond.
Other labor-related data was less ambiguously soft: Tuesday’s Job Openings and Labor Turnover Survey (JOLTS) report2 was an obvious miss, with 7.67 million job openings falling short of economists’ estimates by almost half a million jobs and leaving the index at its lowest rate since early 2021, when the post-COVID recovery was just gathering steam. Meanwhile, a running tally of layoffs complied by Challenger, Gray & Christmas surged in August, up nearly 200% from July’s count.3 More tellingly, companies that responded to Challenger’s survey have said they plan to hire fewer than 80,000 workers this year, the lowest year-to-date total since the outplacement firm began tracking that data in 2005. (Incidentally, that’s even lower than the number recorded during the previous low in August 2008, about midway through what would later become known as “The Great Recession.”)
If hitting the ball right down the middle like last week’s jobs data appeared to do is sometimes a bad thing, being normal in an upside-down world can be just as awkward — just ask the U.S. yield curve. To wit: One consequence of all the above-cataloged labor market softness was a further easing in interest rates as traders tried to position themselves for a friendlier Fed. Unsurprisingly, shorter-term rates (which are more sensitive to Fed policy) fell faster than longer-term rates (which tend to pay closer attention to longer-term economic performance). That allowed the inversion of the yield curve, which celebrated its second birthday early last month, to finally heal itself, returning to normal after remaining upside down for a historically unusual length of time.
Insofar as an upside-down yield curve is often thought to portend recession, its correction last week should be a good thing, right? Evidence, maybe, that we have sidestepped a broader economic slowdown after all? Well, not necessarily. Investors are beginning to realize that the signal transmitted by an inverted yield curve might be loudest and most relevant only after it fixes itself. The intuition here is solid, if not immediately obvious: When the curve flips upside down in response to Fed tightening — as it did in July 2022 — it will likely remain so until the Fed is in a position to ease (which is clearly the case today). But the problem lies in the Fed’s tendency to over-shoot, to tighten policy so much or so quickly that it not only cures inflation but also causes economic growth to plummet toward recessionary levels.
The issue isn’t so much that the Fed is trying to tip the economy over but how difficult it is to get the timing exactly right. Economic variables like labor, consumer demand, and capital spending always react to higher rates in unpredictable ways, and the post-pandemic experience carries with it an unusually high degree of uncertainty that likely lengthened some of the inevitable lags between tighter policy and economic weakness and perhaps shortened others. Said a little differently, it’s always hard to get the timing right, and this time perhaps more so because of the unprecedented nature of the COVID pandemic and the economic disruption it implied. As a result of all that uncertainty, last week’s data only stoked fears that now that the Fed is finally in a position to begin cutting rates, it might already be too late to prevent a deeper contraction in the economy (or even recession). That, as much as anything, might help explain why last week’s un-inversion wasn’t met with any more cheer than good-but-not-great payrolls numbers.
So middle-of-the-fairway jobs numbers and an un-inverted yield curve failed to inspire anything close to a “risk-on” tone amid traders last week. Notably, that’s a switch from just a few months ago, when falling rates and a moderating job market would likely have been met with aggressive buying in a classic “bad news is good news” sort of way that sometimes accompanies economic inflection points — especially those wrought by aggressive Fed tightening. But now it seems as if bad news might really be bad again, making future macro data even more important than it has been so far this cycle.
For now, though, the economy continues to muddle along. The services sector did, in fact, continue to pick up the slack for the manufacturing sector (which did, in fact, slide deeper into contraction). That insight came to us via last week’s Institute for Supply Management (ISM) and Purchasing Managers’ Index (PMI) reports4,5,6,7 as well as the Fed’s own Beige Book,8 which as usual found about half a dozen ways to say, “Meh...”
Middle of the fairway, indeed.
What to watch this week
It’s a fairly light week from a macro perspective. Wednesday’s Consumer Price Index (CPI) and Thursday’s Producer Price Index (PPI) releases carry the greatest potential to redirect the narrative as they set the stage for next week’s meeting of the Federal Open Market Committee (FOMC) — the Fed’s official rate-setting body.
Markets are convinced that the FOMC will finally start cutting rates on September 18, nearly two and a half years after first boosting them in March 2022. The only controversy seems to surround the size of the cut: Will it be the standard quarter-point increment that the Fed seems to prefer, or will they one-up themselves and go a “full 50”? Market consensus currently calls for 0.25%, with a little less than a one-in-three chance that the Fed will cut by half a point.9
For what it’s worth, I find no reason to disagree: Chairman Powell painted himself and his Fed into a corner two weeks ago when he told reporters gathered at the Fed’s annual soiree in Jackson Hole that “the time has come for policy to adjust,” all but promising to cut rates at the next opportunity. That sentiment was echoed by fellow Fed Governor Chris Waller last week when he said, “The current batch of data no longer requires patience, it requires action.” That means only a massive upside surprise in either the CPI or the PPI would justify inaction from the FOMC on September 18, and that seems highly unlikely.
While Waller’s comments in particular left the door open to a bigger cut, last week’s middle-of-the-fairway jobs data doesn’t seem nearly bad enough to justify it. In other words, unless the Fed knows something about the economy that the rest of us don’t, something so unquestionably bad that it requires faster action, a quarter-point cut is the most likely outcome. (And if the Fed delivers something bigger, conspiracy thinking will take over, and you could easily see a sharp move to the downside as investors rush to figure out exactly what the Fed knows that caused the FOMC to cut so aggressively.)
So anything other than a quarter-point cut places the market at risk for an upset. Of course, Powell and his pals don’t take their cues from Mr. Market, but they don’t completely ignore him, either. Besides, as we spent the first thousand words of this commentary trying to convince you, the economic data isn’t yet bad enough to demand faster action.
Moving on... Beyond inflation and the Fed, a pair of sentiment surveys are probably worth a glance this week. The first of these, on Tuesday, is the National Federation of Independent Businesses’ monthly survey of small business sentiment. Small firms were hit first and hardest by inflation and the Fed’s rate-tightening campaign to control it, which makes the segment an important barometer of where things might break from here as the Fed readies its first cuts.
On the consumer side, the University of Michigan’s mid-month look at consumer sentiment is due out on Friday. While partisan preferences are clearly influencing consumer surveys in the run-up to election night, the UofM’s latest update might provide context into how the U.S. consumer is holding up. For my money, though, Monday’s consumer credit release from the Federal Reserve might provide a more reliable view because it includes data on credit balances and credit card rates plus other data that enables you to paint a more comprehensive picture of the extent to which credit is underwriting continued consumer activity.
Finally, for you political junkies, Tuesday’s presidential debate could be worth a watch. Tail risks aside, I’m a firm believer that elections are mostly noise as far as markets and the economy are concerned. Given that, I’d be surprised if anything that is said or done during Tuesday’s debate generates much more than an eyebrow raise on Wednesday morning. That said, though, markets seem legitimately hungry for more meat surrounding both candidates’ economic proposals, and if one or both deliver, it’s entirely possible that you could see some winners and losers emerge, particularly at the industry or sector level. So tune in and enjoy the show — at the very least, it should be entertaining.
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Tom Nun, CFA
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Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.
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