Wentz Weekly: Powell & Slowing Labor Market Provide Optimism For Rate Cuts Beginning September

Wentz Weekly Insights
Powell & Slowing Labor Market Provide Optimism For Rate Cuts Beginning September

Last week’s move in stocks was basically more of the same – the largest seven companies performed well while the other 473 were flat or negative. The S&P 500 gained 1.95% in the holiday shortened, and very quiet, week. The big outperformer was Tesla and its 27% gain over improved optimism on vehicle deliveries. The gains were even better for the Nasdaq with its 3.50% increase, but not so much for small caps where the small cap Russell 2000 index fell 1.02%. The equal weight S&P 500 index saw a very small decline for the week.

Meanwhile, the fixed income markets rallied after seeing a big reversal in rate cut expectations. After the PCE price index two weeks ago and last week’s labor market data, markets are now pricing in a 77% chance for a rate cut at the September meeting, a 35.5% for at least two rate cuts by the November meeting and a 27% chance of at least three rate cuts by the December meeting (there are four Fed Monetary Policy meetings left this year – July 31, September 18, November 7, and December 18). These are all big increases compared to what markets were expecting one month ago.

The result last week was a 16 basis point decline in the 2-year Treasury yield, which is back down to 4.61%. This is the lowest level for the 2-year yield since March, indicating the expectation for lower rates over the next 12 months.

The other event driving yields lower was an appearance and comments by Fed Chairman Powell at a moderated discussion in the European Central Bank’s Forum on Central Banking. In Powell’s first public comments since the June 12 FOMC meeting, he mentioned there has been “quite a bit of progress” in bringing inflation lower and added the trend in disinflation (a decrease in the rate of inflation, NOT a decline) appears to have resumed. He also indicated rate cuts may begin at some point later this year. Markets celebrated these comments with higher stock and bond prices despite him reiterating cuts are not imminent and the Fed needs to be more confident disinflation will continue.

The jobs report on Friday provided even more optimism. The Department of Labor said payrolls grew by 206,000 in June, about 20k more than expected, with job growth averaging 222,000 per month so far this year. However, that is where the good news ends. April and May saw downward revisions to job growth totaling 101,000 less jobs added that initial estimates. In addition, government saw the most job gains in June of 70,000. Excluding government jobs, to looks at just the private sector, shows job gains of 136,000, lower than the six-month average.

Wage growth appears to be slowing as well – the average hourly earnings of $35.00 per hour grew 0.3% in the month, slowing from 0.4% with the annual increase at 3.9%, dropping to the lowest annual increase since May 2021.

The household survey had more indication of a slowing labor market. This data showed the number of people employed, or civilian employment, increased 116,000 and has averaged just a 3,000 increase each month this year. At the same time, the number of people unemployed rose 162,000 and is up 814,000 from a year ago. This resulted in an unemployment rate of 4.1%, an increase of 0.1% from May, for the highest since November 2021.

For much of the past two years the data gathered from establishments has been stronger than the data gathered from households. This could be due to several different factors including the impact of immigration and people finding a second job. For example, over the past year, nonfarm payroll (from the establishment survey) is up 2.611 million while civilian employment (from the household survey) is up just 195,000 over the same time frame.

Another item to note is full time employment has declined 1.6 million over the past year while part-time employment is up 1.8 million. While we are not saying we are in a recession, a decline in full time-employment like this is typically associated with recessions, so is something worth watching closely over the next year.

Add on to this continuing unemployment claims are at their highest level since November 2021 and you can see there are pockets of weakness in the labor market. This may provide the Fed with more evidence of a slowing economy, which will help bring inflation lower, and potentially keep them on path for rate cuts later this year, something the markets are increasingly pricing in.

Now this week will be busier with investors looking forward to Thursday’s newest inflation data with the consumer price index, then Friday’s unofficial start to second quarter earnings season with some of the big banks reporting. As of last week, the consensus sees second quarter earnings increasing 10% from a year ago, driven by large cap tech. Until then it should be a quiet start to the week outside of Powell’s testimony to Congress where nothing new is expected.

Stocks have now moved higher nine of the past eleven weeks, with last week’s gains driven by the top names and the major indices finishing as follows: Nasdaq +3.50%, S&P 500 +1.95%, Dow +0.66%, and Russell 2000 -1.02%. Meanwhile, due to repricing of rate cut expectations, with markets expecting more rate cuts over the next 12 months, fixed income markets had a solid week as Treasury yields fell across the curve – the 2-year Treasury yield fell 16 basis points to 4.61% while the 10-year yield fell 11 bps to 4.29%. Oil moved higher again over strong demand, continued Middle East tensions, and worries of supply disruptions with a 2.0% weekly gain. The dollar index fell 0.94%, gold rose 2.5%, while Bitcoin fell 6.1% for the fourth straight weekly decline.

Recent Economic Data

• Employment Report: The June jobs report showed that 206,000 jobs were added in the month, more than the 185,000 expected but slowing from the 272,000 job gains seen in May. However, May’s number was revised down 54k to 218,000 while April’s was revised down 57k to 108,000. Jobs gains have averaged 222,000 per month so far this year, down from the average of 251,000 in 2023. Government saw the most job gains of 70,000, and excluding government (because we want to look at private sector job growth) was 136,000, so excluding government is was a much weaker report than headlines suggest. Elsewhere in the establishment survey, the average hourly wage hit $35.00 for the first time ever, rising 0.3% from last month and rising 3.9% from a year ago, matching the slowest annual increase since May 2021. Annual wage growth has averaged 4.7% so far this decade, compared with the 2.4% average in the 2010’s. Turning to the household survey, which has shown a divergence from the establishment survey, the total number of people employed, or civilian employment, increased 116,000 and has averaged just a 3,000 increase each month this year and 16,000 over the past year. The number of people unemployed rose 162,000 and is now up 814,000 from a year ago, possibly a big red flag. This resulted in an unemployment rate that rose 0.1% to 4.1% for the highest since November 2021. The U-6 rate was unchanged at 7.4%.

  ADP Employment: ADP reported its payroll data saw 150,000 new payrolls in June, right near expectations and right around the gain from May. Payroll gains were seen across all employer sizes and higher in most industries, led again by leisure & hospitality.

• Job Openings & Labor Turnover Survey: The number of job openings in May was slightly higher than expected but relatively unchanged compared to April at 8.140 million opening. Job openings have steadily been on a downtrend since peaking at an all-time high of 12.182 million March 2022. Over the past year openings are down 1.171 million. That means now for every unemployed persons there are 1.22 job openings. The total number of separations was 5.422 million, rising almost 100k from the prior month but 400k below a year ago. Within separations, quits were 3.459 million, a big drop from 4.009 million a year ago, indicating people are sticking with their jobs longer or no longer confident in finding a better or higher paying job.

• Jobless Claims: The number of jobless claims the week ended June 29 was 238,000, an increase of 4k from the prior week and back near the highest level of the past 12 months. The four-week average was up 2k to 238,500. The number of continuing claims was 1.858 million, an increase of 26k from the prior week for the highest level since November 2021. The four-week average for continuing claims moved up 17k to 1.831 million. We are starting to see more consistent upward move in jobless claims and continuing claims – something to follow closely as its one of the first signs of weakness in the labor market.

• PMI Index: The US PMI manufacturing index was 51.6 for June, right in line with expectations and reflects a slight increase in manufacturing activity compared to May. The report noted new orders rising for the second straight month, production turning for the better but still weak, input prices eased more, though “continued to rise sharply,” and the most positive was a big bump in employment, the most since September 2022. However, business confidence hit a new 19-month low.

• ISM Index: The ISM manufacturing index was 48.5 for June, dropping slightly from May indicating manufacturing conditions weakened further in the month, a different picture than what the PMI survey showed. The ISM survey said new orders remain negative, production fell further, prices index fell which is a positive for inflation although still indicates rising prices, and employment remained negative. Notes on the survey included companies unwilling to invest in capital and inventory due to current policy and general conditions.

• ISM Services Index: The ISM services index was 48.8 for June, below the 52.5 expected and dropping back into contraction territory (below 50) for the lowest level in over four years – since the lockdowns of the pandemic. New orders were weak, dropping 7 points to 47.3 with business activity also below 50, dropping 12 points to 49.6. The prices paid index, the indicator for inflation, fell 2 points to 56.3, but still elevated. Meanwhile, employment fell for the sixth time in the past seven months at 46.1.

• Construction Spending: Construction spending disappointed for the third consecutive month after reporting a 0.1% decline in May versus the expectations of a 0.3% increase. However, April’s construction spending was revised from the initial estimate of a 0.1% decline to a revised 0.3% increase. For May, spending on residential construction fell 0.2% while spending on nonresidential fell 0.1%. Compared to a year ago construction spending is up 6.4%, driven by both a 6.6% increase in residential and 6.2% increase in nonresidential.

• Trade Data: The US trade deficit was $75.1 billion in May, widening by $0.6 billion compared to $74.5 billion from April, and to the largest deficit in 19 months. The wider deficit was due to a $1.8 billion, or 0.7% decline in exports combined with a $1.2 billion decline, or 0.3% decline in imports. Year-to-date the deficit has increased $14.4 billion, or 4.2%, compared to the deficit the same period 2023. A wider deficit is a negative contribution for GDP so we may see another downward revision for Q2 GDP. Another way to look at the data is looking at cross border volume to measure the amount of economic activity where trade volumes are lower by 0.5% compared to last month but still 5.4% higher from a year ago.

Company News

• Tesla Delivery Update: Tesla shares rose about 6% after reporting it delivered 444,000 vehicles in Q2, ahead of the estimates of 440,000 vehicles. Many analysts have cut their delivery estimates for Tesla coming into the news, so expectations were pretty low.

• Paramount Merger Talks: Paramount and its parent company National Amusements have been reported by the WSJ to have come to an agreement on terms to merge Paramount with Skydance Media, a deal that has been in the works for a while but fell apart last month. The report says Skydance would acquire National Amusements and then merge Paramount. The terms of the deal were not released, but CNBC reported the deal is expected to be completed by the weekend.

• Walmart Exiting Healthcare: According to Fortune, Walmart has held talks with healthcare companies over a possible sale of its healthcare business, which includes 51 clinics and its virtual healthcare business, with one possible suitor being Humana.

• Ads on Meta’s Threads: Meta Platforms CEO Mark Zuckerberg said Facebook’s Threads app has surpassed 175 million monthly active subscribers, which was just launched July 2023. Bloomberg is reporting Meta is now considering monetizing Threads by offerings ads. Meta said the ads would be more targeted and personalized than those on X (Twitter).

• Apple’s Big Expectations: Based on orders of chips that go into the iPhones, Apple is expecting big sales for its iPhone 16. According to CTEE and reported by Apple Insider, Apple has increased its chip orders with TSMC, the producer of chips that power the iPhones. The chip order indicates Apple is preparing to sell between 90 million and 100 million units, a big increase from the 80-90 million in order volume for the iPhone 15 last year.

Other News:

• Presidential Immunity: The Supreme Court ruled on party lines that former presidents have immunity from prosecution for acts taken while in office and immunity from criminal charges. This will likely delay Trump’s trial regarding January 6th and complicates it even further.

• What Will Biden Do: There has been a lot of different speculation on what Democrats will do for the Presidential election with Bloomberg saying the Democratic National Committee is considering formally nominating Biden as early as mid-July to quiet the crowd that has been talking about replacing him as their candidate. There has been a growing pressure by many Democrats for Biden to withdraw as the Democratic candidate. This past weekend, ABC aired an interview with President Biden where he reiterated several times he is staying in the race.

• Oil on the Rise: Gas prices have drifted higher and crude oil prices have steadily increased since the beginning of June and just hit the highest level since the beginning of April at $84/barrel over rising demand amid the strong summer travel season and geopolitical worries in the Middle East. Oil also saw upward pressure due to worries that the hurricane making its way through he gulf could impact production.

• Disinflation Resuming: Fed Chairman Powell’s first comments since the FOMC meeting indicated the economy has made “quite a bit of progress” in its inflation mandate, adding that the trend in disinflation appears to be resuming (after several months the beginning of this year of seeing no progress). He went on to reiterate the Fed needs to be more confident this will continue before starting to cut rates, indicating rate cuts are not imminent but confirmed they may begin at some point later this year, while warning the Fed will be patient and slow because moving too fast will have inflation return.

• UK’s General Election: The United Kingdom held its general election where the opposition Labour Party won by a landslide over the outgoing Conservative party who saw their biggest defeat in almost 100 years after being in control for 14 years. Polls going into the election were indicating an easy win for the Labour Party, but an outright majority was uncertain. They did win 400 seats, over the 326 required for an outright majority and will now form the next UK government, making it a disappointing night for the conservatives and incumbent Prime Minister Rishi Sunak. British markets are rallying as a result over more certainty and avoiding a hung Parliament. Labour policy (which is left on the political spectrum) is said to be much more business friendly now than it has historically.

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