Bumpy Economic Ride Replaces Soft Landing

The July jobs report is dedicated to the Hollywood classic, All About Eve where Bette Davis’ character Margo Channing warned partygoers, “Fasten your seatbelts; it's going to be a bumpy night.” The same could be said of the labor market, which is slowing down faster than expected and putting the Federal Reserve’s much-desired “soft landing” in jeopardy.

In July, the economy produced 114,000 positions, shy of the 185,000 that analysts predicted and lower than the 2024 monthly average of 203,000. Further evidence of the deterioration in the labor market was seen in wage growth, which decelerated to 3.6 percent from a year ago, lower than 3.9 percent in the previous month. The unemployment rate increased from 4.1 to 4.3 percent, the highest level since October 2021. Notably, July marked the fourth consecutive month where the unemployment rate increased. Since 1960, every time we have seen four consecutive months where the unemployment rises, we subsequently land in a recession.

Of course, this time could be different, but the fear of a slowdown is part of the explanation of stock market losses and bond market gains. Short term investors are worried that if the economy slows down too much, or (gasp!) lands in a recession, then consumers will pull back their spending and companies will not be able to make as much money.

The slowdown talk also puts the Fed’s inaction at its July policy meeting in the spotlight. Although the central bank could cut rates any time it deems necessary (there’s no rule that they need to make announcements at their scheduled meetings), Fed watchers believe that the more likely scenario is that if data confirm further softening, the central bank could potentially cut rates by a half of a percentage point, rather than a quarter, at the September meeting. Currently, investors are expecting a full percentage point (one half and two quarters) shaved off from the Fed funds rate by year-end. The acceleration of rate cuts helped boost the bond market, as income investors try to lock in interest rates while they are still elevated.

Stephen Brown of Capital Economics warns that we should be careful and “treat the July Employment Report with caution” because of the potential impact of Hurricane Beryl. In its report, the Labor Department said that Beryl “had no discernible effect on the national employment and unemployment data”, but Brown says that “there are some signs that it played a role, with the number of workers absent due to weather rising sharply.”

Even if July is revised in the subsequent months, there is little doubt the economy is downshifting. We heard from companies like McDonald’s and Starbucks that consumers are exhausted from high prices and are already reducing their spending on discretionary items like burgers and coffee.

Fasten your seatbelts; it's going to be a bumpy night.