The Economy
So, ‘Suddenly’ Is Suddenly Here?
August 2024
In a decidedly less interesting book, Bill Gorton’s question might have been “how do expansions end?” and while Mr. Hemmingway, thankfully, opted to go a different route, Mike Campbell’s reply would have been exactly the same: “two ways, gradually, and then suddenly.” While history may, as we expect will be the case, prove otherwise, it sure seemed like “suddenly” got here at 8:30 AM on August 2 in the form of the July employment report. The report showed a marked slowdown in nonfarm job growth, a jump in the unemployment rate, a drop in average weekly hours, and a deceleration in wage growth. That the July employment report is deeply flawed seemed to, with an assist from the BLS, have gone largely overlooked, as it triggered a stunning decline in yields on U.S. Treasury securities, a sharp selloff in equities, and a chorus of recession calls, many of which came from analysts whose calls had been different at 8:29 AM on August 2.
Suddenly, indeed. It is more than fair to ask whether the economy was really any different at 8:31 AM on August 2 than it was at 8:29 AM on August 2. To help set the stage for this discussion, recall that the July FOMC meeting concluded two days prior to the release of the July employment report. As was widely expected, the FOMC left the Fed funds rate unchanged but set the stage for a twenty-five basis point cut in the funds rate at their September meeting, an outcome that markets, and most analysts, seemed to have taken in stride. The following day, however, brought the July ISM Manufacturing Survey, which showed the manufacturing sector in contraction for the twentieth time in the past twenty-one months, and the weekly data on initial claims for unemployment insurance, which showed the highest number of filings since last August.
Between initial jobless claims and the ISM Manufacturing Index, markets were already on edge on Thursday, August 1, with equity prices and yields on U.S. Treasury securities dropping during the day. That set the stage for what took place in the aftermath of the release of the July employment report the following day. Kind of. We can at least understand the reaction in equity markets, where many had for some time been expressing concerns that valuations may be on the lofty side. As such, the prospect of the economy shifting into a slower pace of growth would have meant that some resetting of valuations was in order, particularly amongst the tech giants. So, one could argue that, while the stage was set for a pullback in equity prices, the only thing missing was a catalyst, which apparently arrived at 8:30 AM on August 2.
Still, that pullback was almost surely intensified by a number of analysts reacting to the July employment report by making sudden and sharp changes to their forecasts of the paths of monetary policy and the broader economy. For instance, many who prior to the release of that report had a “soft landing” scenario and fifty basis points of Fed funds rate cuts by year-end as their base case suddenly pivoted to recession calls and forecasts of 125 basis points, or more, of funds rate cuts by year-end, with some going as far as to call for the FOMC to implement a fifty-basis point cut prior to the September FOMC meeting. Such pivots added to worries over economic growth, which contributed to the steep decline in yields on U.S. Treasury securities on August 2.
While the sell-off in equities was, at least to some extent understandable, the reaction amongst those analysts making sharp and sudden pivots in their forecasts was, and remains, somewhat puzzling. Aside from the July employment report clearly being riddled with noise which, the BLS’s assertion to the contrary, includes meaningful impacts from Hurricane Beryl, signs of a slowing pace of economic growth did not suddenly materialize during the first few days of August. Indeed, we have for some time now been pointing to what we have seen as clear signs of a slowing pace of economic growth. We have for even longer been pointing to cooling demand for labor while noting that numerous collection/measurement issues have made the monthly employment reports less reliable snapshots of labor market conditions.
That that the ISM’s July survey showed the manufacturing sector in contraction was nothing new. Moreover, at 46.8 percent in July, the headline index remained above 42.5 percent, which ISM pegs as the line between contraction and expansion in the broader economy, a line that the headline index has not come close to crossing during this twenty-one month run of weakness. As for the data on initial jobless claims, the increase to a nearly one-year high fueled concerns of a pronounced deterioration in labor market conditions, as if gradually might be turning into suddenly. We did not think too much of the increase in initial claims; not only were claims still being inflated by increased filings in Texas in the wake of Hurricane Beryl, but the pattern in claims over the prior several weeks was in keeping with the summer spikes seen over the past few years, spikes which receded in subsequent weeks, suggesting issues with the seasonal adjustment process. To that point, over the final two weeks of July the net change in not seasonally adjusted claims was minus 64,728 while the net change in seasonally adjusted claims was plus 4,000.
As for the July employment report, though the BLS stated that Hurricane Beryl had “no discernable effect” on the July data, the data seem to say otherwise. The household survey data show 436,000 people did not work at all during the July survey period due to adverse weather, while 1.079 million people who normally work full-time worked only part-time due to adverse weather. At the same time, the number of people who reported being on “temporary layoff” rose by 249,000 in July, the largest increase since the early stages of the pandemic, which added two-tenths of a point to the July unemployment rate, i.e., the reported increase from June. Moreover, unlike the household survey, the establishment survey requires one be physically present at work at some point during the survey period to be counted as employed. The spike in initial claims for unemployment insurance benefits in Texas in the weeks after Hurricane Beryl suggests the July count of nonfarm payrolls was held down by Beryl.
In short, neither how we analyze the economic data nor how we see the economy evolving was any different at 8:31 AM on August 2 than it was at 8:29 AM on August 2. Our base case has been, and remains, that after the significant distortions in economic activity over the past few years wrought by the pandemic and the policy response to it, the pace of economic activity is reverting back toward the roughly two percent trend rate seen over the decade prior to the pandemic.
To be sure, it is more than fair to ask whether that “normalization” is what we are now seeing or whether/to what extent the added burdens of a prolonged period of rapidly rising prices and higher interest rates will push the economy past that point, to the downside that is. It is, however, also more than fair to ask what could possibly have changed so dramatically and what was suddenly seen on 8:30 AM on August 2 that wasn’t visible at 8:29 AM on August 2 to warrant the sharp and sudden pivots made by many analysts after the release of the July employment report.
Time will tell whose calls on the economy are closer to the mark. For now, however, it could be that enough FOMC members interpreted the July employment report as a warning that policy is too restrictive and, as such, now feel a more aggressive course of Fed funds rate cuts is in order. To that point, we have added a third 25-basis point funds rate cut to the baseline forecast (the November FOMC meeting). This, however, would reflect the FOMC making policy less restrictive at a faster pace, reflecting progress on inflation and slowing growth, as opposed to the FOMC shifting to an accommodative policy stance to fend off recession.
Sources: Bureau of Labor Statistics; Institute for Supply Management
As of August 7, 2024
