Signs of cooling in labor markets as Federal Reserve holds rates steady

Cooling in the labor markets

The July ADP report on private job growth came in lower than expected last week, at only +122,000 job additions compared to the expected +150,000. Construction, trade, transportation, and utilities jobs provided the bulk of the gains, while professional and business services suffered the largest contraction. Year-over-year wage growth among individuals who have remained in their jobs for at least twelve months came in at 4.80%, the lowest reading in almost three years. While weakening labor markets are not generally a good thing, equities rose in response to the readings, as investors expect that this latest data will further increase the probability of a rate cut in September.

Fed Chair Jerome Powell spoke about the future of interest rates on Wednesday afternoon, and while it’s difficult to say whether the ADP report influenced his messaging, he did refer to the Federal Reserve’s dual commitment to 2.00% inflation and robust employment, which contributed to the market’s interpretation of his speech as dovish.

On Friday, the unemployment rate rose to 4.30%, an increase of 0.20% from the previous month. Nonfarm payrolls increased by a disappointing +114,000, falling short of the expected +175,000. Additionally, June’s figures were revised down to +179,000 from +206,000, and May’s gain was adjusted to +216,000 from +218,000. As a result, the Sahm Rule was officially triggered Friday with the unemployment release; the rule is a recessionary indicator when the three-month average unemployment rate rises by at least 0.50% from its low in the past year.

Starting from Friday into today, the market reacted to these releases with a plummet in U.S. equities, and the 10-year Treasury yield fell to its lowest level since June 2023. The two-year Treasury has now fallen as much as 70 basis points in the last week, though major volatility persists. Looking abroad, the Nikkei is down 12.40%, which is its lowest drop since the “Black Monday” of 1987, when global markets crashed unexpectedly and is known as the largest one-day stock market drop in history. In the wake of these developments, some market participants have claimed that the Fed must conduct an emergency rate cut for markets to bounce back. The report has spurred controversy and many view it as a stretch, but at the very least, the Fed should seriously consider rate cut prospects for September.

Consumer sentiment

Despite the cautiously optimistic tone of Powell’s press conference last week, in which he referenced substantial declines in inflation, continued low unemployment, and greater-than-expected second quarter GDP growth as positive signs, consumer sentiment remains stubbornly low. Michigan’s consumer sentiment came in at 66.40 in July, which is down from the high of 79.40 that appeared earlier this year, and well below the mid-90s readings that were common in the pre-COVID era. It seems that consumer perception of price increases has significantly outweighed other economic positives like wage growth and low unemployment. Moreover, with the recent labor market reports, fears of a recession have entered the conversation, evidenced by rallying rates and the stock market plummet.

Mixed signals in oil markets

Oil prices jumped more than 3.00% on Wednesday, as the assassination of a Hamas political leader led Iran to order a retaliatory strike on Israel, creating risk of supply shortages. The threat of broader regional conflict put upward pressure on prices, but the gains were more than offset later in the week following negative macroeconomic indications in the U.S. Specifically, the big miss on nonfarm payrolls sent crude oil falling on recessionary fears and a potential hit to demand. The ISM and S&P manufacturing indices showed another month of contraction, with the ISM coming in well below expectations at 46.80, compared to the consensus 48.00. The combination of geopolitical uncertainty and sensitivity to market indicators has led some corporates to think more actively about hedging crude exposure in recent months. Chatham often helps companies design hedging structures that reduces risk to the PNL while retaining ability to participate in favorable market moves, in times where market conditions are unpredictable.

The week ahead

Markets will assess the impact of the stock market decline, while traders speculate on the timing and magnitude of rate cuts. Richmond Fed President Tom Barkin will speak on Thursday afternoon and may give more insight into the Fed’s outlook for the rest of this year. Additionally, the choice of a Democratic Vice Presidential candidate may also hint at the broader economic policy of a Harris presidency, especially given the current state of the market.