Could investors be overreacting? Possibly, but the reality is that, with inflation having receded, real (inflation-adjusted) interest rates have risen and could be having a negative impact on economic activity. In his comments earlier last week, Fed Chair Powell said, “I would not like to see material further cooling in the labor market. If we see something that looks like a more significant downturn, that would be something that we would have the intention of responding to.” Investors in recent days indicated that they expect Powell to respond.
Let’s examine the details of the jobs report. The US government releases an employment report that has two components: One is based on a survey of establishments; the other on a survey of households. The establishment survey found that 114,000 new jobs were created in July, the second smallest number since early in the pandemic. There was a decline in employment in information, financial services, and professional and business services. The only industries that saw strong job growth were construction, health care, and leisure and hospitality.
Meanwhile, the establishment survey reported on wage behavior. Specifically, it found that average hourly earnings of workers were up 3.6% in July versus a year earlier, the smallest increase since May 2021, and were up only 0.2% from the previous month. Although wages are still rising faster than inflation, the deceleration of wages is good news from an inflation perspective. It is consistent with a weakening of the job market.
Finally, the separate survey of households found that the number of people participating in the labor force increased much more than the rise in the working-age population. Thus, with a modest increase in employment, the unemployment rate rose from 4.1% in June to 4.3% in July, a nearly three-year high. However, the sharp rise in participation suggests confidence in the availability of jobs.
In the business press, the word “recession” appeared last week with greater frequency. Could we face a US recession in the coming months? There are some negative indicators: The slowdown in the job market and the rise in the unemployment rate, a decline in new orders for manufacturing according to a survey by ISM, weak new orders for durable goods, and a rise in credit card delinquencies. On the other hand, consumer spending and business investment have both remained strong while job growth is still at a speed that is consistent with moderate economic growth. Thus, there remains uncertainty. My view is that, if the Fed acts strongly in September, investors will likely rejoice, boosting asset prices and engendering confidence. A recession could be avoided. However, predicting the timing of recessions and recoveries is not one of the strongest skills of economists.
- Meanwhile, before the release of the jobs report, the US Federal Reserve’s policy committee left the benchmark interest rate unchanged. Yet the wording of the Fed’s statement, as well as comments from Fed Chair Powell, reinforced the view that the Fed will indeed cut the rate in September.
The Federal Open Market Committee (FOMC) said that there is “somewhat elevated” inflation, a more moderate description than in the previous meeting when it simply said “elevated” inflation. More importantly, the FOMC is evidently pivoting from a focus solely on inflation to a focus on both inflation and employment. Remember, the US Congress has mandated that the Fed target both. The recent statement said that “the committee is attentive to both sides of its dual mandate,” whereas over the past two years it has described policy as “highly attentive” to inflation. Also, Fed Chair Powell said, “We have made no decisions on future meetings,” adding that “the economy is moving closer to the point where it will be appropriate to reduce our policy rate.” Investors can reasonably interpret these statements as boosting the likelihood of a rate cut in September.
The newly stated focus on employment comes at a time when the unemployment rate is up and job growth has receded. Plus, there are reports of rising financial stress for households, consumers trading down, and consumer-oriented companies facing weaker revenue and earnings. On the other hand, economic growth was strong in the second quarter, consumer spending was strong in June, and business investment has been strong despite high interest rates. Regarding inflation, the numbers have been favorable, but service inflation remains far too high.
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