Continued Moderation in the Labor Market - Call for Action

“There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time.” That’s one of the most important things you can know about investment risk.” ~ Howard Marks

With Fed Chair's Front and Center focus on evolving outlook of the US employment situation, this week carried extra significance and the Employment data catalyzed the move in Yields. Yields on US2s fell 35 bps (High - Low Range) and on US10s 28 bps (High - Low Range) over the week. On US2s Yields, we closed right at 3.65% and on US10s at 3.71% which is in close proximity to the braking point we mentioned earlier in the backdrop of the larger H&S Formation. We did not get the upticks towards the 4.10% handle we were hoping for. Another Trade I had thought about and did not write was the break below the 3.90% - 4.10% consolidation range but that's because consolidation break outs many times chop you out so better to trade at the top of the consolidation where the SL is tight rather than play on break outs.

Whether we follow through on the price action during this week on CPI / PPI release or retrace the move is to be closely watched.

Generally, Monday's tend to be follow throughs of Friday's price action and Tuesday's we get the reversal - just something to be cognizant of. 

US2s10s dis-inversion continued through the week with the spread closing at +6.20 bps, levels last seen in July 2022. In the last week blog entry, we spoke about the technical triangle that has a potential target of 15.50 bps on Us2s10s. 

Over the week, we only got a 23.6% retracement on the USD move to 101.92 Level from where we reversed and closed the week at 101.19. 

The market is pricing in 59% probability of 125 bps of rate cuts as against a 98% probability of 100 bps of rate cuts in 2024. In the next 1 year, cumulative rate cuts priced by the market hold a 74% probability of 250 bps of rate cuts. Which means that softer inflation prints or poor Economic data could push the pricing to 100% probability of 250 bps cuts. For the upcoming 18 September Policy, there stands a 70% probability of 25 bps of rate cuts. 

Nick Timiraos of the WSJ writes that the August report was not bad enough to seal a 50 bps rate cut but wasn't good enough to rule it out as well. 1 Option with the Fed would be to cut 50 bps in this policy and another option would be to cut by 25 bps and signal several more cuts when they release the Statement of Economic Projections. 

Estimates of Atlanta Fed GDP now stand at 2.10% (40 bps lower from last week). Cleveland Fed Estimates for Core PCE for August and Sep are trending at 0.26% mom and 0.27% mom and 2.8% yoy and 2.7% yoy respectively. 

Brent Crude Prices were down 9% on the week and the set up looks very constructive for a much sharper move lower. A monthly H&S formation that has broken below the trendline at 76.50 and closed the week at 71.50.

The data on Jobless Claims is summarized below and not much to write about since IJC is moving around the averages and CJC pulled back from yearly highs of 1860K. 

The JOLTS data came in below consensus expectations alongside a downward revision to the previous month's figure. We love to keep going back to Christopher Waller's Speech and look at 2 metrics which helps us to give a framework on the Employment picture  - the Vacancy Rate and the Ratio of vacancies to Unemployed people. The Vacancy Rate has been steadily declining and the Ratio of Vacancies to Unemployed People has been steadily coming off and is now closer to levels last seen in 2017. So steadily and surely, the Employment numbers are coming into better balance. 

The U/R declined 10 bps to 4.20% and the NFP grew 142K , below consensus expectations but still a decent number and the prior 2 months were revised down by a total 86K. AHE grew 0.40% and 3m average hourly earnings grew 0.30%. The average payroll gain printed at 267K in the first quarter, 147K in the subsequent quarter and the most recent 3m payroll gain has averaged 116K. Governor Christopher Waller pointed out in this speech that the recent rise in U/R appears to be more of a supply side driven phenomena and not demand driven. He also makes an interesting point that a slower pace of Rate cuts allows the FOMC to judge if the neutral rate has in fact risen but a faster pace allows for a more assured soft landing but at the risk of overshooting on rate cuts. A significant deterioration in labor market means FOMC can act quickly and forcefully to adjust monetary policy. 

Nonfarm business sector labor productivity increased 2.5% in the second quarter of 2024, as the output increased 3.5% and hours worked increased 1.0%. Unit labor costs in the nonfarm business sector increased 0.4% in Q2 2024, reflecting a 3.0% increase in hourly compensation and a 2.5% increase in productivity. Unit labor costs increased 0.3% over the last four quarters, the lowest rate since the fourth quarter of 2013, when the measure decreased 2.2%. 

Obviously, as I tried to analyze the data, I see that the Economy is cooling but I don't see an outright recession in the numbers or the Economy falling off a cliff. The concern is that the data could rapidly deteriorate and the Fed would have to cut quickly and forcefully to adjust policy. Going forward it means that the market sensitivity to poor Economic Readings or Beta as we call it runs high. If you have been reading my blog posts, I often speak about the Risk Pendulum and the pendulum is moving towards pricing more and more bad news for the market. Let the markets price the worst of the worst before you fade moves. 

Next week is a price heavy week, CPI (wed) and PPI (thurs) are expected to rise 0.20% mom and 0.20% mom respectively. IJC on Thursday and the Michigan Consumer Sentiment is scheduled for Friday.