Why Macroeconomic Fragility Will Likely Push Stock Markets Higher
The economy and labor markets will likely continue to deteriorate - and investors couldn't be happier.
The story of the market and broader economy over the past two years has been about inflation and interest rates. Chairman Jerome Powell has made it clear throughout that time that unless inflation moves sustainably lower, they will not cut rates.
However, the recent CPI data print, combined with weakening labor market trends indicate disinflation may accelerate. This new story is reflected in betting markets: investors are now anticipating an 80% chance of a rate cut in September.
Image credit: Kobeissi Letter
Consequently, a weakening labor market and eroding macro-fundamentals could give the Fed impetus to cut interest rates. The prospect of looser credit conditions after the fastest tightening cycle in 40 years will likely be a tailwind for Wall Street.
Since February, I have been warning readers that the economy is not as resilient as people think, and co-authored a more detailed report in April. Digression aside, what was the most recent inflation data print and what does it mean?
CPI Data, Market Response
Last week, CPI data came in weaker than expected, but the economy is also showing signs of frailty. That may be bad for job seekers but great for the stock market.
Core inflation rate YoY for June: 3.3% ➡ 🔻0.1% relative to forecast of 3.4% Inflation rate YoY for June: 3.0% ➡🔻0.1% relative to forecast of 3.1%.
After that data print, investors started pricing in what they view as a near-certainty of a 25 bps rate cut at the FOMC meeting in September. That reading reinforced the market's predisposed hope for rate cuts this year.
At the same time, the labor market continues to show signs of weakness. This may surprise many of you, but headlines about stellar job growth are insincere.
Beneath the Surface
According to a report from Vanguard, the hiring trends show a notable disparity between lower-income and higher-income workers. According to their proprietary data, the hiring rate for workers earning less than $55,000 annually remains robust at about 1.5%, which is above pre-pandemic levels.
This trend is consistent with greater labor market activity in lower-wage sectors such as leisure and hospitality and retail trade.
In contrast, the hiring rate for employees earning more than $96,000 annually has significantly slowed to 0.5%, which is less than half the peak it reached in mid-2022. This decline marks the lowest hiring rate for this income group since 2014, excluding the early months of the pandemic.
In the meantime, part time unemployment is up 336,000 jobs, while full-time employment is down by 653,000 workers over the same period. And, as Kobeissi Letter points out: jobs numbers have been revised down 4/5 months in 2024. They will likely be revised lower again.
Furthermore, between January and June, around 50% of all job creation for each month was in government roles and the healthcare sector. *In some cases, it was as “low” as 41%, and as high as 60%. There are a few reasons behind this.
1.Post-Pandemic Recovery: Post-pandemic recovery efforts have seen increased government spending and hiring in public health, education, and infrastructure, which has led to a more pronounced contribution of government jobs to overall employment growth.
2.Economic Stimulus: Recent economic stimulus measures have led to increased hiring in various government roles, contributing to the overall job creation figures.
3.Healthcare Demand: The healthcare sector continues to experience robust growth due to ongoing public health needs and an aging population, maintaining its role as a significant contributor to job creation.
So, how could this be good for markets?
A weaker labor market will mean consumer spending will shrivel as pandemic-era savings from H2 evaporate. Softer consumption will likely lead to further disinflation, lending credence to the notion the Fed will cut rates because inflation is moving "sustainably lower".
And to avoid over-tightening for too long, weaker macro-fundamentals also support the notion that the Fed should cut rates to avoid a recession. As all of this unfolds, markets - which are forward-looking - will cheer at the prospect of incoming rate cuts and data supporting it.
What to look out for ahead
In the week ahead, a number of key data prints will be published that will further contextualize the state of macroeconomic affairs. Some notable events include:
Monday: Fed Chair Powell Speaks (All in all, there are a total of 11 Fed speaker events this week)
Tuesday: June Retail Sales data
Wednesday: June Building Permits data
Thursday: Philly Fed Manufacturing data
Continuing to monitor labor market trends will be crucial because of what cascading effects it has on sentiment, risk appetite, and spending patterns. Stay tuned for more.