Job Flop — Good News for a September Rate Cut or Too Little, Too Late?

The jobs report for July wasn’t the calm descent into stable normalcy that the Federal Reserve — and everyone else — wanted. Consensus expectations were 185,000 new nonfarm jobs and continued unemployment of 4.1%, according to polling of economists by Dow Jones. What arrived was 117,000 jobs and unemployment shooting up to 4.3%. May and June jobs were revised downward by 29,000.

Many observers predict that the results almost locks in a September rate cut. But comments go further. Combined with a fourth straight month of manufacturing contraction as the Institute for Supply Management (ISM) reported, and weakening wages, this has raised concern that the Fed has waited too long for cuts.

As various executives at the central bank have mentioned multiple times, there is a danger in monetary strategies. Make a timing mistake in changing rates and inflation could return. Go the other direction and the economy could tip into a recession. The Fed has been walking a tightrope for many months.

“The job is not done on inflation. We have more work to do there. But at the same time, we need to be mindful of where the labor market is,” Fed Chair Jerome Powell said to Congress last month.

Surprises in labor markets have been mostly to the high side over the last year. This one is the opposite and seems to have triggered the Sahm rule recession indicator, named for economist Claudia Sahm. The rule is an observed correlation that has displayed strong accuracy including retroactive analysis of previous recessions. When the three-month moving average of the national unemployment rate is at least 0.5 percentage points to the low point of the three-month unemployment rate average over the previous 12 months, a recession has supposedly already begun.

Sahm is careful about what the rule might indicate, having written late last month that it “is likely overstating the labor market’s weakening due to unusual shifts in labor supply caused by the pandemic and immigration.” She added that the “risk of a substantial weakening or a recession in the next several months is elevated, adding to the case for the Fed to begin cutting rates.”

Bringing the conversation back to the Fed. Douglas Porter, chief economist at BMO Economics, wrote that “the companion household survey reports that only 57,000 more Americans have jobs now than a year ago, a growth rate of 0.04% y/y. That’s a pace that has typically preceded downturns, and hints that even the sluggish payroll readings may be overstating the economy’s strength.”

And there are other implications. “Yesterday’s market selloff coupled with the drop in the ten-year Treasury yield served as an accurate precursor to this morning’s disappointing and worrying report,” said Quincy Krosby, chief global strategist for LPL Financial. “Treasury yields dropped again indicating an impending economic growth scare while equities are becoming increasingly focused on the implications of a decidedly cooler backdrop.”

At the end of Thursday, yields on the 10-year Treasury were back to 3.99, falling below the psychologically important 4.0 figure. If that downward drift continues, it could mean greater interest on the part of investors in alternative investments like CRE because the lower chance of a reasonable risk-free return.