Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
Equities surged last week, with the major indices recording their best weekly performance of the year, as bond yields retreated from recent highs and investors viewed weaker than expected jobs data as a sign that the economy is making its final approach to a soft landing. The buoyant mood on Wall Street got a further assist as Federal Reserve Chairman Jerome Powell highlighted the progress made in reining in inflation from post-COVID highs despite still robust growth in the economy. Those comments, which were made following the Federal Open Markets Committee’s decision to hold rates steady, were seen by many as a sign that the Fed was likely done raising rates and the battle against inflation was winding down with the economy still intact. The question now is whether the labor market will slow enough to snuff out the Fed’s concerns about increasing wages continuing to fuel inflation without slowing so much that we get actual job losses. We remain concerned that the Fed will keep rates high for too long and that what has been an easing of hiring will gain momentum and could turn to net losses of jobs, which could result in a recession.
While Powell praised the progress, he also cautioned that it is “likely that we will need to see some slower growth and some softening in the labor market (and) in labor market conditions to get to fully restore price stability.” The pace of disinflation has stalled and by some measures has ticked higher. Consider that the Cleveland Federal Reserve’s inflation reading, called the 16 Percent Trimmed Mean Consumer Price Index, which excludes components that show the most extreme monthly price changes, has moved higher recently. After slowing to a more historically normal annualized pace of 2.56 percent in July, the August reading came in at 3.56 percent annualized, and September’s level rose to 4.93 percent. The rise in price pressures is also corroborated by the latest Trimmed Mean Personal Consumption Expenditures (PCE) measure from the Dallas Federal Reserve, which shows median PCE rising at a 3.99 percent annualized rate in September. Given the Fed’s concerns about wage growth and the pause in progress in inflation measures, we believe the Fed will maintain the current restrictive rate levels until there is sustained evidence that the labor market has sufficient slack and wage growth slows to less than 3.5 percent on a consistent basis. Unfortunately, we believe, the longer it takes for the impact of the 525 basis points in already enacted rate hikes to wind their way into the employment picture and bring wage growth down further, the more likely it is that the overall economy will fall into contraction.
That’s because, as we noted in last week’s commentary—and Fed Chair Powell acknowledged in his press conference, the total weight of the rate hike cycle has yet to be felt. Thanks to historically low interest rates in the years leading up to the pandemic, many consumers and businesses have been sheltered from the impact of higher rates as they continue to service loans made at the previous lower rates. However, as time goes on, debt servicing costs will climb throughout the economy as loans are repriced at the current higher rates, and the added costs will begin to take a toll on economic growth. Eventually, slower growth coupled with easing worker demand could reinforce each other and lead to an overall economic contraction. Fortunately, the supply and demand imbalances during the COVID era have been resolved, and those price pressures have largely disappeared. As such, the Fed should be able to cut rates to spur economic activity quickly if and when a downturn occurs.
Wall Street wrap
As noted above, much of the data out last week suggests that the red-hot employment picture is beginning to cool. Not surprisingly, it is happening at a time when other reports are showing a slowing economy.
Signs of a moderating job market: The nonfarm payroll report for October released late last week by the Bureau of Labor Statistics indicated that hiring eased last month, with 150,000 new positions added, less than half of the 297,000 new positions recorded in September. For further context, the average monthly gain over the past 12, six and three months was 243,000, 206,000 and 203,000, respectively, suggesting that while still strong, the trend in hiring is slowing. Digging further, the bulk of the new jobs were for health care, government and social services employees. In the private sector, hiring narrowed, with 52 percent of the industries covered by the report adding employees, down from September’s 61.4 percent. The percentage of private-sector industries hiring was at the lowest level since April 2020, the height of the economic shock from COVID. For further context, the narrowness of hiring echoes previous periods that have typically preceded recessions.
While the report suggests some softening in the employment picture, wages remain elevated. Average hourly earnings for production and non-supervisory employees rose by just more than 0.3 percent from September and are up 4.4 percent year over year, down 0.1 percent from September’s year-over-year pace. While the pace of wage growth has slowed over the past few months and is well below recent highs, we believe that it is still too high for the Fed to achieve its goal of 2 percent annual inflation.
The BLS’s other jobs report, the household survey, showed 348,000 job losses in the month and an uptick in the unemployment rate to 3.9 percent, up 0.1 percent from September and the highest level since January 2022. The total number of unemployed people has risen to 6.506 million, up from April’s level of 5.657 million. This equated to a six-month rate of change of 15 percent. Going back to 1951, 10 of the 11 times when there has been an increase equal to or greater than what has occurred in the past six months, we have been in or on the cusp of recession. Similarly, according to the Sahm rule, developed by former Federal Reserve economist Claudia Sahm, since 1960, every time the three-month moving average unemployment rose by 0.5 percent or more from the previous low, a recession has followed; currently, the unemployment rate (at 3.83 percent) is 0.43 percent above the most recent low. The increase in the unemployment rate came despite the labor participation rate declining to 62.7 percent, down from the previous reading of 62.8 percent.
Jobless claims increase: Weekly jobless claims numbered 217,000, up 5,000 from last week’s upwardly revised figure. The four-week rolling average of new jobless claims came in at 210,000, an increase of 2,000 from the previous week’s revised average. Continuing claims (those people remaining on unemployment benefits) were at 1.818 million, an increase of 35,000 from the previous week and up from the low of 1.658 million in early September. Although the most recent data shows that layoffs remain relatively low, the upward trend in continuing claims suggests displaced workers are finding it more difficult to find new jobs. Continuing claims are now 27 percent higher than year-ago levels; typically, going back to late 1960, an increase of this magnitude has indicated the economy is either in recession or on the verge of entering one.
Manufacturing weak but stabilizing: The latest data from the Institute for Supply Management (ISM) shows the manufacturing sector notched a 12th consecutive month in contractionary territory. The composite reading for the index came in at 46.7, down 2.3 points from September’s reading of 49 (readings below 50 signal contraction). Readings for new orders declined to 45.5, down 3.7 points from the prior month. Backlog orders were little changed at 42.2, down marginally from the prior reading of 42.4. Employment fell back into contractionary territory at 46.8, 4.4 points lower than in September. Prices paid moved higher but remained at contractionary levels, with the latest reading coming in at 45.1, up from last month’s level of 43.8. The latest data suggests that the improvements seen in September are still fragile and that the manufacturing sector continues to struggle. In a statement accompanying the latest report, Tim Fiore, chair of the ISM, noted, “Demand remains soft, but production execution is stable compared to September as panelists’ companies continue to manage outputs, material inputs and—more aggressively—labor costs.”
Growth in services sector shows more signs of slowing: ISM data for the services side of the economy showed that the pace of expansion continued to slow, with October’s headline reading for the sector coming in at 51.8, down from 53.6 in September (readings above 50 signal expansion). While still in expansionary territory, the latest reading marks the lowest level since May. New orders rose to 55.5, up from September’s reading of 51.8. Despite the uptick in new orders, inventory sentiment continues to suggest levels are too high, with the latest reading at 54.4, down modestly from 54.8 the prior month. The slowdown in growth on the services side of the economy may also be starting to wear on demand for workers. The latest results from the survey showed the employment index declined to 50.2, down 3.2 points from September’s reading of 53.4.
Consumer confidence declines on persistent inflation concerns: Consumer confidence continued to decline in October, marking the third consecutive month of falling readings as concerns about price pressures continue to weigh on consumers. The Conference Board’s consumer confidence index fell to 102.6 in October, down from the prior month’s upwardly revised reading of 104.3. The expectations index, which measures consumers’ short-term outlook for income, business and labor market conditions, fell to 75.6 from September’s reading of 76.4 in August. Recall that readings below 80 on the expectations index have typically coincided with the arrival of a recession in the coming 12 months. Despite a more pessimistic view, consumers’ outlook on the job market stayed mostly steady.
As a part of the index, the Conference Board measures how easy or difficult respondents find it to land a job. In October, those saying it’s hard to get a job edged lower to 13.1 percent, down from 14.2. Meanwhile, those who viewed jobs as plentiful also moved lower, to 39.4, down slightly from 39.7 in September. The gap between those who find it hard or easy to get a job is the labor differential, something we’ve been tracking closely due to the Fed’s focus on the employment picture. October’s labor differential came in at 26.3, up from September’s revised reading of 25.5. This measure is considered a leading indicator of the labor market. As such, it is worth noting that, while modestly higher in October, the trend is toward a tighter differential. The gap stood at 40.7 as recently as February of this year and was at 47.1 in March 2022, suggesting that the labor market is cooling.
Housing prices move higher: The latest S&P CoreLogic Case-Shiller Index shows home prices climbed 0.9 percent in August on a seasonally adjusted basis from the prior month, marking the seventh monthly increase in a row. August’s reading shows home prices are up on a year-over-year basis, rising 2.6 percent since August 2022. While recent data suggests that the housing market has stabilized after the swoon experienced during the first half of the year, we believe high interest rates will continue to cause affordability issues for potential buyers and keep the housing market under pressure.
The week ahead
Monday: A light week of data kicks off with the release of results from the Federal Reserve’s Senior Loan Officer Opinion Survey in the afternoon. The past few surveys have shown tightening lending standards at large and mid-sized banks. We will be watching for signs of further tightening as well as the state of loan demand.
Tuesday: The Federal Reserve will release its latest look at the financial condition of consumers through its Consumer Credit report. Consumers have begun to take on more credit card debt in recent months, but overall balance sheets have remained mostly resilient. We will be watching for changes in debt levels in light of recent data showing increased spending.
Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings were up again last week, as were continuing claims, and we will continue to monitor this report for sustained signs of changes in the strength of the employment picture.
NM in the Media
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Brent Schutte, Chief Investment Officer, discusses his outlook for inflation, wages and the likelihood of a recession. Watch
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As the chief investment officer at Northwestern Mutual Wealth Management Company, I guide the investment philosophy for individual retail investors. In my more than 25 years of investment experience, I have navigated investors through booms and busts, from the tech bubble of the late 1990s to the financial crisis of 2008-2009. An innate sense of investigative curiosity coupled with a healthy dose of natural skepticism help guide my ability to maintain a steady hand in the short term while also preserving a focus on long-term investment plans and financial goals.
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