Pivot! Pivot!

It was both a Brat Summer, and the Summer of Revisions. The Bureau of Labor Statistics (BLS) reported their annual audit of the employment numbers from March 2023 to March 2024. Initial estimates showed the U.S. added 2.9 million jobs over that time period, or 242,000 a month. Their revision puts the actual job growth at 2.1 million jobs between March 2023 and March 2024, which is the equivalent of 172,000 a month. Gross Domestic Product - or the total value of all goods and services consumed in the economy - also got a makeover. With most of the revisions to the upside up until the end of 2023, economic growth post-covid has been stronger than initial estimates:

Measuring the economy is hard. These revisions are normal and typical. You may have heard this is the biggest revision to the labor numbers since 2009, which is when we were in the depths of the financial crisis. While that may be bad company, there are other logical reasons for why the revision was so high - including continued data collection problems stemming from COVID - and it doesn't necessarily mean we're in the midst of a recession. Yet. 

PIVOT! PIVOT! The Federal Reserve (Fed) announced a 50 basis point cut in interest rates at their meeting in September. This brings their new range to 4.75% - 5.25%. Monthly CPI and PCE numbers continue to show the economy trending back towards the Fed's 2% inflation target. The Fed is now pivoting its attention to the other side of its mandate - stable employment. The Fed has two mandates given to it by congress; price stability and maximizing employment. It manages these two mandates, mostly, through the power of raising or lowering interest rates. The Fed raised rates in an effort to slow down economic activity and slow down price inflation. With prices inflation trending closer to its target, and unemployment beginning to tick up, the Fed decided not only to lower interest rates at its last meeting, but to 'front load' their cutting cycle with a larger 50 basis point cut. Perception can be just as powerful as reality, and the perception of a 50 basis point cut shows the Fed is willing to cut interest rates more quickly if the data they follow deteriorates more quickly. Merely saying this can cause financial conditions to loosen beyond actual rate cuts. Can the legen (wait-for-it) dary 'soft landing' actually happen? Market participants seem to think so, so far...

Using the S&P 500 as a proxy, the stock market was close to a correction in both August and September. Recession fears continued to creep in based on conflicting data points on the Labor Market. The fear of a weak U.S. labor market, combined with the Japanese central bank raising interest rates by surprise, caused a de-leveraging event and heightened volatility. I will explain both, for those who are curious!

I mentioned it during my intra-quarter message, but the Sahm Rule was triggered in August. In Layman's terms, the Sahm Rule basically says that when the unemployment rate ticks up by a certain amount in a certain time period, then it tends to accelerate and rise more quickly. Almost every time the Sahm Rule has been triggered historically, a recession has followed. 

[Insert the biggest HOWEVER in the history of economics here] there was an argument to be made that this may have been a fake-out this time around. The rise in the unemployment rate was a knock-on effect from the expansion of the labor participation rate and how all of these numbers are calculated. The labor participation rate is calculated based on the total number of people working or SEEKING work in the overall economy.  When people enter the labor force, the labor participation rate increases. But, not everyone entering the labor force does so by being employed - people can join the labor force by simply seeking a job. The labor participation rate has been expanding through 2023 and 2024 because of strong growth in immigration (there's a very strong argument that immigration has kept our economy growing, while other developed countries have contracted, contrary to 'popular' opinion...). More people are joining the labor force, but are not yet employed, therefore the unemployment rate has been rising artificially.

The full labor situation didn't become more clear until September, but it was enough to spark a sell-off when the BOJ (Bank of Japan, Japan's Central Bank) simultaneously raised interest rates to above 0% for the first time in over 10 years!

Quick history lesson!

Japan's economy has been struggling ever since a technology boom turned into a bust in the 80s and 90s. Similar to our own central bank, they lowered interest rates to 0% in hopes to spur economic activity. Growth never fully recovered so they tried something for the first time in modern monetary history, negative interest rates. There were a number of ~quirky~ effects that occurred from this policy decision that's a little too 'in the weeds' for this newsletter, but the one concept to understand is the yen-carry-trade.

Because interest rates were negative in Japan, investors all over the world slowly put on a trade where they borrowed in yen, and then purchased assets elsewhere. Where elsewhere? The U.S. Stock market, babyyyyy! This trade really picked up steam when central banks all over the globe started raising interest rates, with the U.S. Fed raising rates to one of the highest ranges of all developed countries. Investors began piling into this trade hand-over-fist because you could now borrow from the Japanese central bank essentially for free, and then buy U.S. Treasuries (considered the 'safest' asset in the world) for a guaranteed return of 5% or more. 

What goes up, must come down! The Labor market scare caused yields in the U.S. to fall, while yields in Japan were raised by surprise. What did investors do? They sold all those U.S. assets in order to buy back their loans in Yen. The increased selling activity all at once from investors all over the world caused the U.S. Stock market to gap down quite quickly.

More labor market data has been released since then which showed we may have overreacted.  The Fed is now fully on the rate cut side of the cycle, and the BoJ has promised to be more transparent and telegraph its interest rate decisions with more notice. Markets now sit at an all time high. The labor market is definitely weakening, tensions in the middle east are rising, the U.S. presidential election is still a month away, and there's a real potential for port strikes to cause prices to increase again. More volatility still may be ahead of us.