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.
Average hourly earnings growth remained low at 0.20% in April (2.4% annualized), signaling that inflationary pressures are easing.
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.
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.
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).
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.
The GDPNow model from the Atlanta Fed forecasts an optimistic 3.3% annualized real growth rate in Q2.
But the Lewis-Mertens-Stock Weekly Economic Index is far more cautious at an annualized rate of 1.7% for Q2 (so far).
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%.
The Services New Orders sub-index remains above zero, suggesting some improvement ahead.
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.
The Prices sub-index, on the other hand, warns of persistent inflation, rebounding to a strong 59.2%.
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.
The Chicago Fed Financial Conditions Index recovered slightly to -0.47, also warning that easy monetary conditions are receding.
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%.
The S&P 500 jumped above resistance at 5100, suggesting another test of resistance at 5250. But we first expect retracement to test support.
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.
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.
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.
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.
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
- Institute for Supply Management: Services PMI
- CoinDesk: Bitcoin Prices
- Congressional Budget Office: Budget and Economic Outlook – 2024 to 2034
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