Labor Market Weakness Triggers Stock Market Sell-Off, Likely Rate Cuts
Weekly Economic Review: July 29, 2024
Last week became a turbulent one after a weak July jobs report and a jump in unemployment led to recession fears by many analysts and market participants. Prior to release of the jobs numbers, the emerging data – the Employment Cost Index (ECI), the Job Openings and Labor Turnover Survey (JOLTS) – all appeared to be consistent with a gradual cooling of the labor market and the overall economy. The Federal Reserve opted to keep rates unchanged at its mid-week meeting. Those stable trends all disappeared with Friday’s release of the July jobs numbers. Stocks fell sharply, the dollar dropped to a four-month low against a basket of currencies, and treasury yields declined across the curve, with yields on the benchmark 10-year Treasury Note falling to their lowest level since December. But on closer examination, did the economic numbers justify the market reaction? Let’s parse out the ECI, job opening & labor turnover, Federal Open Market Committee (FOMC) meeting and jobs data announced last week.
Job Creation and Employment. Last Friday’s jobs figures showed new job creation slowed significantly in July. The Bureau of Labor Statistics (BLS) announced that businesses added just 114,000 new jobs in July, much lower than the 175,000-gain expected. The July job growth was primarily driven by gains in the health care, construction, and transportation and warehousing sectors. At the same time, the June and May jobs numbers were both revised down. The June jobs number was revised down by 27,000, from 206,000 to 179,000, while the May number was lowered by 2,000, from 218,000 to 216,000. After these revisions, July’s job creation data appears to represent the continuation of an accelerating downward trend.
The unemployment rate rose unexpectedly to an almost three-year high, rising to 4.3% in July from 4.1% in June and 4.0% in May. Once again, the numbers appear to represent an accelerating negative trend. The July unemployment rate increased more than the 4.1% expectation and was primarily driven by an increase of 352,000 in the number of unemployed people, partially offset by a 67,000 increase in household employment. But the jump in unemployed workers was mainly attributable to temporary layoffs rather than permanent layoffs. The number of people on temporary layoff, which is defined as workers given a date to return to work by their employer or expecting to be recalled to their jobs within 6 months, increased by 249,000 (or 31%) to 1.1 million in July, after decreasing 23,000 in June and 35,000 in May. There was little change in permanent job losers and long-term unemployment. At the same time, the participation rate (the percentage of working-age people who are employed or are actively looking for work) increased to 62.7% in July from 62.6% in the prior month, as 420,000 workers entered the labor force last month. The growth in temporary (versus permanent) layoffs, combined with the sharp rise in workers entering the labor force, may have caused the rise in the unemployment rate to appear more significant than it actually is.
Beyond that, wage growth (average hourly earnings) rose 0.2% last month after advancing 0.3% in June and 0.4% in May. On an annual basis, wages increased 3.6%, which is the smallest gain since May 2021 and following a 3.8% advance in June and a 4.1% rise in May. Both monthly and annual wage growth (average hourly earnings) evidenced slowing, and came in lower than market expectations, reducing any inflationary pressure from the job market. Wage growth in a 3-3.5% range is consistent with the Fed’s 2% inflation target.
Labor Productivity and Costs (Preliminary): The BLS announced nonfarm labor productivity for the second quarter, indicating that labor productivity increased 2.3% after advancing only 0.4% in prior quarter, as output increased 3.3% while hours worked increased only 1.0%. On an annual basis, labor productivity increased 2.7% after advancing the most (2.9%) in three years. This is well above the 1.4% annual pace over the past 15 years. If sustained, that would allow the economy to grow faster and wages to increase more without inflation. Furthermore, the increased productivity indicates that businesses are strengthening efforts to reduce the impact of higher operating costs.
Unit labor costs increased 0.9% in the second quarter after climbing 3.8% in prior quarter, resulting from a 3.3% increase in hourly compensation and a 2.4% increase in productivity. The second quarter figure represents the smallest advance since the pandemic. Unit labor costs increased 0.5% over the year, the lowest rate since the third quarter of 2019.
Employment Cost Index: The BLS announced the ECI, measuring the total compensation (wages and benefits) of employees, for the second quarter. This is the Fed’s preferred wage measure over average hourly earnings numbers from the monthly jobs report, as the ECI is free from the effects of workers moving between occupation and industries. The ECI increased by 0.9% in the second quarter after advancing 1.2% in the prior quarter (the most in a year). This came in lower than market expectations. Annual compensation cost increased 4.1% year-over-year, which is the smallest since 2021.
Job Opening and Labor Turnover Survey (JOLTS): The BLS announced its JOLTS for June, indicating that the number of job openings decreased slightly, by 46,000 to 8.18 million from an upwardly revised 8.23 million (originally 8.14 million) in May. This was higher than market expectations, but down by 941,000 from a year ago. The reduction was mainly driven by decreases in manufacturing, finance and insurance, health care and social assistance, and federal government sectors. This was partially offset by increases in the state and local government and leisure and hospitality sectors. The June reading indicates that the labor market is slowly cooling but has solid demand for workers even though businesses have pulled back on hiring and wage growth has slowed.
The ratio of openings to unemployed people was unchanged at 1.2, the lowest since June 2021. Also, the number of hires declined 314,000 to 5.341 million, which is the largest decrease in 16 months. The hires rate declined from 3.6% in May to 3.4% in June, the lowest level since the onset of the pandemic. This was mainly driven by decreases in leisure and hospitality and professional and business services. Layoffs decreased 180,000 to 1.498 million, the lowest since November 2022. The labor market slowdown is being driven by reduced hiring rather than layoffs and is gradually normalizing where supply and demand conditions in the labor market have come into better balance.
The number of people who voluntarily resigned their job declined 121,000 to 3.28 million in June. The quits rate, the rate at which workers voluntarily leave their jobs, excluding retirements, held at 2.1%. The stable quits rate is dampening wage pressures, which bodes well for the overall inflation outlook.
FOMC Meeting: The Federal Reserve completed its two-day FOMC meeting, deciding to keep interest rate unchanged as expected for the eighth consecutive meeting. Federal Reserve Chair Powell indicated in his press conference that a rate cut could be implemented as soon as September, and that the Fed’s focus will be attentive to the “dual mandate” of both inflation and employment rather than just focusing on inflation. The FOMC statement reiterated that the Fed doesn’t expect to reduce rates until it has greater confidence that inflation is moving sustainably toward 2%. The statement further indicated that price pressures remain somewhat elevated, but that there has been further progress toward its inflation goal.
On a concluding note, after the events of the past week, market participants paid closer attention to the Sahm rule, which has been a reliable recession indicator with a perfect track record over the last 50 years. The rule states that if the three-month average of the unemployment rate is 0.5% or more above its low in the prior 12 months, the economy is in a recession. The recession indicator is 0.53% following 0.43% in June and 0.37% in May. The rule’s creator, Claudia Sahm, recently indicated that the economy doesn’t appear to be in a recession but is not headed in a good direction.
The market is afraid that the Fed may be cutting rates too late. Friday’s payroll report shifted the debate from when the Fed will cut to how large the cuts will be in its upcoming meetings in September, November and December. A few weeks ago, the market was betting that the Fed will lower in two 25-bp cuts this year. However, as of today, Fed funds futures probabilities of rate cuts indicate that the market anticipates a total of a 1% cut by the end of this year with a 50-bp cut in September, a 25-bp cut in November and a 25-bp cut in December.
It’s clear that the economy, inflation and labor market have been downshifting and are continuing to do so. But the noise in Friday’s jobs report, which triggered recession fears and thereby creating a panic in the domestic and international stock markets, may have overstated the extent of the problem. All things considered, the market shouldn’t overreact to one data point and should be more patient.
Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California
Thomas McCullough
EVP of Commercial Bank of California
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