Weak jobs and falling crude = September rate cut

Key Points

  • The Fed will likely cut interest rates in September after a weak jobs report.
  • Falling crude oil prices also ease inflationary pressure.
  • Long-term Treasury yields fall, anticipating a rate cut.
  • The dollar weakened as yields softened, while gold soared to a new high of $3,600 per ounce.

The August labor report disappointed with a low 22,000 job growth compared to an expected 75,000. Another June data revision saw jobs contract by 13,000, after initial reported gains of 147,000 were revised down to 14,000 last month.

Employment Growth

Growth in total weekly hours worked came to a complete halt in August, with annual growth falling to 0.7%. Real GDP growth will likely follow.

Total Hours Worked

The uptrend in continued claims confirms the August rise in the unemployment rate to 4.3%.

Unemployment

The unemployment level ( 7.4m ) now exceeds job openings ( 7.2m ), but only by 200K.

Job Openings

Temporary jobs fell to 2.5 million, a level typically seen during recessions.

Temporary Employment

Layoffs and discharges are in an uptrend.

Layoffs & Discharges Rate

The 2.0% quit rate indicates that employees are no longer confident in finding new jobs.

Quit Rate

Average hourly earnings growth slowed to an annualized rate of 3.3% in August, but year/year growth was steady at 3.9%, still indicating a balanced labor market.

Average Hourly Earnings

Crude Oil

OPEC+ has injected a lot of downside pricing risk into the oil markets this week, fueling speculation that the second wave of voluntary cuts totaling 1.65 million b/d could be unwound much quicker than previously expected. According to news reports, Saudi Arabia is interested in pushing ahead with the unwinding during the September 7 meeting, citing the need to regain market share. (OilPrice.com)

The move has the potential to create a massive oversupply. Brent crude fell to $65.50 per barrel on Friday, but if the Saudis succeed, expect a test of support at $60. Falling crude prices would squeeze shale producer margins, causing a drop in US production.

Brent Crude

Lower energy prices would ease inflationary pressures in the US, allowing more room for Fed rate cuts.

ISM Services

The ISM services PMI improved to 52% in August, indicating expansion.

ISM Services PMI

New orders jumped to 56%, signaling an improving outlook.

ISM Services New Orders

However, services employment signals contraction, confirming the weak labor report.

ISM Services Employment

A steep 69.2% for the prices sub-index also warns of strong inflationary pressures.

ISM Services Prices

Contracting employment and rising prices in the large services sector warn of stagflation. We expect the Fed to cut in September, but then pause to see how this affects prices.

Stocks

A weak labor report is a bearish sign for stocks despite the prospect of a Fed rate cut. A reversal of the S&P 500 below support at 6400 would warn of a correction.

S&P 500

We expect the Dow Jones Industrial Average to test support at 45,000. Respect of support would confirm another advance. A breach is less likely, but would signal a test of 44,000.

Dow Jones Industrial Average

Financial Markets

The Chicago Fed Index retreated to -0.526, warning that financial conditions are tightening.

Chicago Fed National Financial Conditions Index

Tighter financial conditions are also highlighted by a decline in bank reserves to below $3.2 trillion.

Commercial Bank Reserves at the Fed

Bitcoin is testing support at 110K. A breach would warn of a swing to risk-off in financial markets, which would be bearish for stocks.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields plunged to 4.09%, heading for a test of long-term support at 4.0% as speculators pile into bonds ahead of the expected September rate cut. However, we have warned of the risk that long-term yields rise in response to a Fed cut — as in September last year.

10-Year Treasury Yield

Dollar & Gold

The dollar weakened in response to the poor jobs report, anticipating falling interest rates.

Dollar Index

Gold surged to a new high at $3,600 per ounce before closing at $3,587. Expect another test of support at $3,500, but respect will likely confirm another advance — and our year-end target of $4,000.

Spot Gold

Silver is retracing to test support at $40, but respect will likely confirm another advance and a target of $44.

Spot Silver

Conclusion

Weak jobs growth in August warns that economic growth is slowing, but the ISM services report warns of strong price pressures in the services sector. We expect a Fed rate cut in September but then a pause as the Fed remains wary of stagflation, with low growth and rising prices.

We expect the dollar to weaken in response to rate cuts, with gold and silver soaring to new highs.

The Fed should take care to avoid a repeat of last September, when Fed rate cuts sparked a sell-off in long-term Treasuries, signaling the bond market’s displeasure with monetary and fiscal policy. We believe they will aim for a gradual decline, with a pause after the September cut to assess the impact of tariffs and a slowing economy on prices.

A Saudi move to increase crude oil production would likely drive Brent crude to $60 per barrel or below, giving the Fed more room to cut rates.

Acknowledgments

Long bonds fall as CPI rises, stocks and gold remain bullish

Summary

  • Global long bond yields are rising, driven by fears over government debt levels
  • A sharp jump in services CPI warns of rising inflation in the broad economy
  • Strong liquidity boosts demand for stocks and for gold

Global long bond yields are rising, driven by fears over government debt levels.

Japan’s 30-year JGB yield jumped to a record 3.20% on Tuesday as opposition parties favoring tax cuts and loose monetary policy are expected to gain influence after the July 20 election. (Reuters)

German 30-year government bond yield is testing resistance at 3.26%, the highest since 2011. Investor concerns are focused on increased debt issuance—to fund defense and infrastructure spending—and rising international rates. (Reuters)

The 30-year US Treasury yield is testing resistance at 5.0%, the highest since 2007. The monthly charts below provide a long-term perspective.

30-Year Treasury Yield

10-year Treasury yields are expected to follow, testing resistance at 5.0%.

10-Year Treasury Yield

Rising yields are driven more by long-term structural issues than immediate concerns over an uptick in inflation.

CPI Inflation

CPI growth jumped to 2.7% for the twelve months to June, while core CPI, excluding food and energy, increased by 2.9%.

CPI & Core CPI - Annual

Sticky price CPI and the 16% trimmed mean, reflecting underlying inflationary pressures, jumped to 2.5% and 3.2% respectively.

Sticky CPI

More surprising was the sharp rise in CPI for services, excluding shelter, which is less affected by tariff increases than goods. The June figure is close to a 7.0% annual growth rate.

CPI Services excluding Shelter Rents

This confirms the earlier ISM Services PMI, which showed a sharp rise in the Prices sub-index in May and June. According to the ISM, fourteen of eighteen service industries reported increased prices paid in June. (ISM)

ISM Services Prices

Energy

Energy CPI showed negative growth for the twelve months to June, contributing significantly to the overall low headline CPI rate.

CPI & CPI Energy - Annual

Shelter

Shelter CPI comprises 35% of headline CPI. However, compared to the Case-Shiller 20-City Composite Home Price Index below, we find the index highly artificial and misleading.

CPI Shelter

Food

Food CPI growth increased in June to an annualized rate of 3.8%.

CPI Food

Stocks

The S&P 500 eased slightly in response to the CPI increase, but this is hardly noticeable on the monthly chart below.

S&P 500

The Dow Jones Industrial Average retreated from resistance at 45K. However,  rising Trend Index troughs signal long-term buying pressure, and a breakout above 45K would confirm the S&P 500 bull market signal.

Dow Jones Industrial Average

Financial Markets

Moody’s Baa Corporate bond spread declined to 1.73% after a sharp spike in March-April, indicating ready credit availability.

Moody's Baa Corporate Bond Spreads

The uptrend in Bitcoin indicates strong animal spirits, which are likely to spill over to stocks.

Bitcoin (BTC)

Dollar & Gold

The US Dollar Index is retracing to test resistance at 100 on the monthly chart below. Respect will likely confirm another decline, and our target of 90.

Dollar Index

Gold is consolidating in a bullish pennant on the monthly chart. Rising Trend Index troughs also signal buying pressure. A breakout above 3450 would strengthen our target of 4000 by year-end.

Spot Gold

Conclusion

Long bond yields are rising due to concerns over precarious public debt levels and growing fiscal deficits.

Inflation is still a secondary consideration, but a sharp rise in the CPI for services in June warns of higher inflation in the broader economy. Services are less impacted by tariffs, which are only likely to affect CPI after current pauses have expired and tariff rates are settled.

Liquidity remains strong, supporting high stock prices. A Dow Jones Industrial Average breakout above 45K would confirm the S&P 500 bull market signal.

Demand for gold is also strong, and a breakout above $3,450 per ounce would signal another advance, strengthening our target of $4,000 by year-end.

Acknowledgments

The elephant in the room

A weak seasonally-adjusted increase of 175K in non-farm payrolls had a surprisingly bullish effect on stocks. The increased prospect of rate cuts from the Fed excited investors. The opposite of what one would expect from a sign that the economy is slowing.

Markets are focused on the immediate impact of shifts in data and policy but ignoring the elephant in the room — the long term consequences of current monetary and fiscal policy.

Labor market

Job growth slowed to 175K jobs in April, the lowest since October 2023.

Non-Farm Employment

Average hourly earnings growth remained low at 0.20% in April (2.4% annualized), signaling that inflationary pressures are easing.

Average Hourly Earnings Growth

The unemployment rate is still low at 3.9%. The Sahm Recession Indicator is at 0.37. Devised by former Fed economist Claudia Sahm, the indicator signals the start of a recession when the red line below rise to 0.50%.

The Sahm Rule signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.

The rule has proved a reliable recession indicator in the past but we need to remember that: (a) it is not a leading indicator and normally only crosses above 0.5% after the start of a recession; and (b) this is a far from normal labor market.

Sahm Rule & Unemployment Rate

Non-residential construction jobs are way above previous highs as the industry benefits from fiscal spending on infrastructure and the drive to on-shore key industries such as semiconductors.

Non-Residential Construction Jobs

Average hourly earnings growth (green below) slowed to 4.0% for the 12 months to April (for production and non-supervisory employees) indicating that inflationary pressures are easing. In the past, average hourly earnings growth above the unemployment rate (blue) has caused high inflation as in the 1970s (red circle).

Unemployment Rate & Average Hourly Earnings Growth

Economic Activity

Aggregate weekly hours worked are growing at an annual rate of 1.8%. This is below the rate of real GDP growth, suggesting either that (a) productivity gains from AI and other new technologies are having an effect; or (b) real GDP growth is likely to slow.

Real GDP & Aggregate Hours Worked

The GDPNow model from the Atlanta Fed forecasts an optimistic 3.3% annualized real growth rate in Q2.

GDPNow

But the Lewis-Mertens-Stock Weekly Economic Index is far more cautious at an annualized rate of 1.7% for Q2 (so far).

Real GDP & Weekly Economic Index

ISM Services PMI declined to 49.4% for April, indicating a contraction in the large services sector. Earlier, the ISM Manufacturing PMI was slightly weaker, at 49.2%.

ISM Services

The Services New Orders sub-index remains above zero, suggesting some improvement ahead.

ISM Services - New Orders

The Employment sub-index, however, shows a sharp contraction, falling to 45.9%. The services sector is the major employer in the economy and the negative outlook warns that overall jobs growth could slow rapidly.

ISM Services - Employment

The Prices sub-index, on the other hand, warns of persistent inflation, rebounding to a strong 59.2%.

ISM Services - Prices

Financial Markets

Bitcoin rallied strongly to again test resistance at $64K. Respect of resistance, signaled by a fall below $61K, would confirm the down-trend and warn of contracting liquidity in financial markets.

Bitcoin (BTC)

The Chicago Fed Financial Conditions Index recovered slightly to -0.47, also warning that easy monetary conditions are receding.

Chicago Fed Financial Conditions Index

Ten-year Treasury yields declined on news of the weak labor report, testing support at 4.5%. Breach would indicate a decline to 4.2%.

10-Year Treasury Yield

The S&P 500 jumped above resistance at 5100, suggesting another test of resistance at 5250. But we first expect retracement to test support.

S&P 500

Gold & the Dollar

The Dollar weakened in line with falling Treasury yields, with the Dollar Index testing support at 105. Breach would signal a correction, with follow-through below 104 signaling end of the up-trend.

Dollar Index

Gold continues to test support at $2300 per ounce. If support holds, with recovery above $2350, the shallow correction would be a bull signal, suggesting another strong advance. Otherwise, a test of $2200 is likely.

Spot Gold

Crude Oil

Brent crude broke support at $84 per barrel as tensions in the Middle East ease. Follow-through below support at $82 would warn that the up-trend has weakened and is likely to reverse.

Brent Crude

Conclusion

Financial markets, like Pavlov’s dog, are conditioned to react bullishly to rate cuts. Long-term Treasury yields declined and stocks jumped in response to a weak labor report. However, weak jobs growth is not a bull signal, suggesting that the economy is likely to slow. This is borne out by a weak ISM Services PMI for April, warning of a contraction.

The unemployment rate remains low but average hourly earnings growth is declining, indicating that inflationary pressures are easing. ISM Prices sub indices for both Manufacturing and Services, however, warn of strong producer price pressures.

Brent crude broke its rising trendline and follow-through below the next support level at $82 per barrel would warn of reversal to test primary support at $75. Declining energy prices would help to ease inflationary pressures.

The Fed is likely to hold off cutting rates until the outlook for inflation is clearer.

Gold could weaken to $2200 per ounce in the short- to medium-term — if it can break stubborn support at $2300. But we remain long-term bullish on Gold. The elephant in the room is Government debt which is growing at a rate of more than $1 trillion a year, with little prospect of a bipartisan agreement in Congress to address the shortfall. The chart below shows the bipartisan CBO’s projection of federal debt as a percentage of GDP from 2024 to 2054.

CBO Projections of Federal Debt

The only practical way to solve this is to increase GDP at a faster rate than the debt, through inflation. That would erode the real value of the debt but is likely to send Gold and other real assets soaring.

Acknowledgements