While there was a very outside chance that the Federal Reserve would cut interest rates this week and follow at least one of the two reductions initiated by the Bank of  Canada this summer, we ended up with yet another “pause”. Recent data, from inflation to general business activity, did indeed support a move from the Fed but a critical piece of the puzzle wasn’t going to be available until this morning and that was the July employment report.

 

Estimates of US nonfarm payrolls (month-over-month) and the unemployment rate were +175,000 and 4.1%, respectively. At 8:30am this morning, markets were painted a different picture. The unemployment rate rose to 4.3%, which is the highest level in almost three years and nonfarm payrolls came in at +114,000 (recall that we had downward revisions in the past two months as well). Also signaling a weakening of the US labour market was the month over month change in average hourly earnings coming in at +0.2% vs an estimate of +0.3%.

 

The month-to-month changes in non-farm payrolls tend to be volatile, which is why economists and market participants tend to look at the 3-month moving average. Over the past year, there has been a fairly steady moderation in the pace of growth in jobs, with the 3-month average payroll gain declining from around 270,000 in June of last year to below 180,000 in this past June. The break below 200,000 was the result of the outlier report back in April, where payrolls rose by only 108,000. That said, it is clear that momentum has faded and this is also being reflected in an upward pattern in the unemployment rate.

 

In April of last year, the rate had fallen to 3.4% for the first time since 1969, and the extreme tightness of the labour market was reflected in strong wage growth. By this past June, the rate had climbed back up to 4.1% and this morning we saw a 4.3% rate for July. The move from last year’s low to today doesn’t look like much, but the incremental movements have been closely watched for signs of whether or not the U.S. economy was headed for an outright recession or just a cooling off.

 

 

One indicator that has garnered a lot of attention of late is the so-called Sahm Recession Indicator, which is a Federal Reserve Economic Data (FRED) indicator created by Dr. Claudia Sahm. This indicator is calculated by taking the difference between the 3-month average of the U.S. unemployment rate and the lowest level of that average over the prior 12 months. What Sahm’s  research found was that if this difference reached 0.5% or more, then a recession in the economy has likely begun. The chart above shows this indicator going back to 1949. We have taken this to the end of 2019, as the impact of the pandemic caused the indicator to jump almost 10%. As of June, the number had rise to 0.43% and with this morning’s data, it now stands at 0.53% for July.

 

The proximity to 0.5% this summer was one of the reasons some argued for a Fed rate cut this week and even though that was not delivered, the language in both the statement and Chair Powell’s remarks do suggest that they are cognizant of the fact that employment conditions might already be at a tipping point. Specifically, in response to Bloomberg’s Michael McKee, Powell said that “I think the downside risks to the employment mandate are real now”. This has been construed by the market to mean that the Fed is intent on cutting rates in September, which was the street’s base-case scenario going into this week’s FOMC meeting.

 

 

This was the eighth consecutive meeting where the Fed left its official upper-band target unchanged at 5.5%. Last year, we wrote about the difference between the actual level of rates and the speed with which rates are increased when it comes to predicting the impact on the economy and markets. What we found was that there was something more important than either and that was the length of time between the Fed’s last rate hike and its first cut. This past experience ranks up there with episodes where there was a deterioration in both. The Sahm Indicator is really just picking up the output from keeping rates high.

 

Although certain indicators might be pointing to a more pronounced deterioration in the economy than we want, it’s also important to point out that the Fed funds rate is just one factor. It is often said that a central bank is like a fly on the back of a dog’s tail, thinking that it is really steering the dog, when there are various other things causing fido to go left and right. That analogy may not be completely accurate today, however we would argue that the market has been doing much of the heavy lifting for the Fed. Bond yields have declined significantly in recent months and this has allowed borrowing costs for both consumers and businesses to come down as well. To the extent that this insulates the U.S. from a more severe pullback in activity, then perhaps the Fed was right to wait until September.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle and Ally Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

Ally Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Ally Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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