2024.08.05 Weekly
A short one today just focusing on some key developments as I’ve to step out for the rest of the day. We had an action packed week where the latest data added fuel to the recession narrative (which I’d categorise as FUD) as well Powell hinting more cuts on the table this year than initially projected.
Let’s review…
Labour market data
The latest Unemployment figures triggered the so-called ‘Sahm-rule’ which is when the 3-month moving average of the U3 Unemployment rate rises by more than 50bps from the 12-month low.
That rule hit 53bps on the Friday’s Jobs report.
According to Claudia Sahm’s paper, Recessions have tended to follow around 3 months after the rule is triggered, but there are reasons to think that this may not be the typical recession trigger where unemployment accelerates higher from this point on.
Firstly, our current economic slowdown is nominally based than it is a ‘real’ slowdown. Previously, the Sahm rule was triggered (from the bar chart above) when growth was already on a slowing trajectory in both nominal and real terms in the preceding 12-months, which is a contrast to our current environment that has real-GDP holding steady at around 3% since Q3 of 2023.
Atlanta Fed’s real GDP estimate inched closer to the range of consensus estimates at 2.5%. These are healthy levels of growth, and much healthier than past periods where the Sahm-rule was triggered:
On top of a robust backdrop, if inflation continues to ease on its current path, real incomes will improve and that will help to cushion a slowdown if not nullify it to a large degree. As Claudia Sahm herself notes:
“This time really could be different and may not tell us what it’s told us in the past, because of these swings from labor shortages, with people dropping out of the labor force, to now having immigrants coming lately, these can all show up in changes in the unemployment rate which is the core of the Sahm Rule.”
“We are not in a recession now — contrary to the historical signal from the Sahm rule — but the momentum is in that direction; A recession is not inevitable and there is substantial scope to reduce interest rates.”
“I am not concerned that, at this moment, we are in a recession; no one should be in panic mode today” noting that household income is still growing, while consumer spending and business investment remain resilient, there are key measures of the economy that “still look really good.”
Despite the unlikely recession, NFP trends is concerning. Not only has total job gains fallen below the pre-pandemic (2015–2019) monthly average of roughly 190k, Private sector job growth on a 3-month average basis is at its weakest since the beginning of 2010 (ignoring the 2020 pandemic year), and Government jobs which have accounted for most of the job gains this year is seeing monthly gains beginning to contract.
There is some debate as to how much the weather impacted the latest employment figures. Looking at the above chart — how could there not have been? Ed Yardeni believes so, but Parker Ross argues that the impact on ‘unemployment’ should be minimal:
While I appreciate Parker’s logic, I’m of the opinion that it must have contributed to ‘some’ weakness in the July data that saw the labour force expand by 420k, a decline in part-time employment after 2 month of gains, less hours worked, as well as a spike in initial claims.
Continuing claims also rose after the initial claims spike, suggesting lingering weakness from the June-July period. Whether or not that is another indication of weather induced weakness, continuing claims has reached the highest reading since Nov’2021.
Consumer & Business sentiment
Confidence continued to steady around the 100 figure at 100.3 in July which came with a downward revision to June from 100.4 to 97.8 that was driven by the Present situation index revising lower from 141.5 to 135.3.
Consumers were increasingly pessimistic about current conditions and though future expectations remained negative, it improved for the 3rd straight month and ‘net pessimism’ is the least since the beginning of the year. Meanwhile income expectations continue to remain positive.
Perhaps the biggest takeaway from the CB report are spending intentions — a significantly larger proportion of consumers expect to spend less across most categories, and particularly in recreational travel and entertainment.
Another weak report which prompted a very negative reaction from the market that surprised me initially given that this print hasn’t particularly moved the market in recent history. Nonetheless, it was a very poor report for the manufacturing sector with the pace of contraction picking up for a 3rd straight month, and the Employment index (which may be what spooked the market) turning sharply lower registering the lowest reading so far this year.
July FOMC review
The change from ‘remains highly attentive to inflation risks’ to ‘is attentive to the risks to both sides of its dual mandate’ in the initial statement confirms the Fed is no longer solely-focused on inflation, and increasingly concerned about labour market risks.
Moving onto the press conference, not only did Powell acknowledge a September cut was essentially baseline, but he may have hinted a reasonable possibility of cutting at every meeting til year-end:
“If we were to see, for example, inflation moving down quickly or more or less in line with expectations, growth remains, let’s say, reasonably strong. And the labor market remains, you know, consistent with its current condition, then I would think that a rate cut could be on the table at September meeting.”
i.e. so long as inflation continues to move down, we are cutting in September’, irrespective of growth and labour market’
I would just say I can imagine the scenario in which there would be — anywhere from zero cuts to several cuts, depending on the way the economy evolves. And I wouldn’t want to lay out at a baseline path for you there today. I’ve said what I can say about September and about today though.
i.e. a cut at each of the last 3 meetings of the year is possible if data continues to evolve on the current trajectory.
Earnings
74% of SPX companies have now reported with the majority (80%) beating EPS expectations.
But top lines have struggled with just 58% beating on Revenues and with just a small margin of positive surprises.
Q3 guidance has also leaned negative. According to FactSet, 39 SPX companies issued negative EPS guidance, and 35 positive.
Still a many more big names to report with major Consumer discretionary and Tech/Semiconductor names reporting in the coming weeks.
Macro calendar
The market feels desperate for some respite against the recent volatility. Perhaps a much quieter calendar this week starting with ISM Services could help . — could it provide some positivity after the dismal Manufacturing report?
Outside the US, we have RBA, NZ employment data and inflation expectations, and CA PMI and Employment data.
Late-cycle views
My current book is long Gold and NDX which is centred around the theme of Fed cuts, inflation coming down, and slowdown concerns (but not as far as a recession) to see the market turn towards late cycle themes that tends to favour Bonds, Gold, and even Technology stocks.
NQ continues to sell-off aggressively and its back to the pivot level of the action seen at the start of the year — Dec’23 high, Jan’24 and Apr’24 lows. It’s also in the 50–61.8 fib retracement towards the pre-QRA lows in Nov’23. I’ve been getting stung quite a bit trying to fade the sell-off, but these are levels where I could easily increase confidence compared to my prior attempts late last month.
Gold should continue to get support with yields collapsing — 10yr real yield is already 20bps off the month’s high and we’re barely into August. There is also some geopolitical risk creeping back with Israel seemingly uninterested in a ceasefire and continuing their assault against Iranian state targets. From a technical standpoint, I am concerned about its ability to perform as its been failing to hold onto gains each time it has had the psychologically huge 2500 handle in its sights, but as long as the potential for faster pace of rate cuts and escalation in geopol risks remain in the fold, I think there is good potential to stay above 2400, and overreach 2500 to 2600.
On the radar for FX, USDJPY vs its 10yr spread is now looking far less overvalued than at the start of July. I think it won’t be long til recession fears are reined in, growth proves to be stable, and carry-FX will stabilize as well. If risk begins to recover from the aggressive unwind, carry FX (e.g. cross-JPY) is likely to find some relief too.
That’s all for now, good luck trading!
