Note: I am travelling (Pacific time zone) until August 10. Posting will be irregular and possibly limited by time and equipment constraints.

July Employment: That Was Sahm Jobs Reports

The ongoing deterioration in the jobs market was on full display in the July Employment report. Nonfarm payrolls expanded by just 114K, well below consensus expectations for a 175K gain and close to the smallest monthly gain this cycle. Revisions were minimal relative to the last two months’ downward adjustment of 111K, but were once again negative with the net change the prior two months lowered by 29K. Over the past three months, payrolls have expanded at an average monthly pace of 170K, down from 267K in the first quarter and 251K in 2023.

(…) the jump in the unemployment rate to 4.3% from 4.1% in June cannot be explained away by the hurricane. The increase in unemployment from 3.5% this time last year is more concerning because the unemployment rate tends to vacillate little throughout the business cycle. Rising unemployment can set off a negative feedback loop between income, spending and hiring.

This dynamic has put a spotlight on the “Sahm Rule,” which highlights the historical pattern that the unemployment rate has never risen 0.5 points above its prior 12-month low (when measured on a three-month average basis) without the economy being in a recession.

July’s unemployment rate reading has pushed the Sahm Rule indicator to 0.53, above its 0.5 point threshold. As we discussed in a recent report, the increase in unemployment has been driven more by entrants into the labor force than at the start of prior recessions. In July, new and re-entrants accounted for 22 bps of the rise in the Sahm Rule indicator over the past year, more than its contribution in the first month of each of the past seven recessions.

Source: U.S. Department of Labor and Wells Fargo Economics

This increase in unemployment for the “right” reasons suggests that the crossing of the 0.5 point threshold may not be the sure-fire sign of recession that it has been in the past. That said, unemployment due to a permanent job loss or completion of temporary work has also risen significantly over the past year, including another increase in July. This increase for the “wrong” reasons underscores that even if the threshold for a recession might be somewhat higher this cycle, there has nevertheless been a clear deterioration in labor market conditions.

Source: U.S. Department of Labor and Wells Fargo Economics

Source: U.S. Department of Labor and Wells Fargo Economics

The looser labor market is having the intended effect of reducing inflation pressures. Average hourly earnings increased 0.2% in July, bringing the year-over-year change down to a three-year low of 3.6%. The moderation adds to other evidence released this week that labor costs are no longer a threat to inflation, including the Employment Cost Index, the Fed’s preferred gauge of compensation costs, slipping to an annualized rate of 3.7% in Q2 and unit labor costs now running comfortably below 2%.

The July jobs report offers the latest indication that the exceptional jobs market that followed the unique circumstances of the pandemic looks to have come to an end. Demand for new workers continues to fade, as evidenced by the downward trend in job openings, small business hiring plans and temporary help employment. Workers have taken notice, with perceptions of job availability and the share of employees quitting their jobs falling to cycle lows.

The weakening trend in hiring, unemployment and job switching over the past year puts conditions on par with the late 2010s. While the labor market remains in decent shape in an absolute sense, further softening would be hard to attribute to “normalization” and instead would be consistent without outright weakness in our view.

We expect the FOMC to begin dialing back the current level of policy restriction soon. Although inflation has not yet returned to the Fed’s 2% target, the cooler jobs market points to inflation pressures continuing to recede. Our forecast remains for the FOMC to reduce the fed funds rate beginning in September by 25 bps at every other meeting through 2025, although growing risks to the employment side of the Fed’s mandate suggest a 50 bps cut in September could also be on the table as more and/or a faster pace of rate cuts look increasingly warranted.

Suddenly, bad news is actually treated as bad news by the markets. Nasdaq officially entered a correction, down 10.8% from its July 11 record high.

Right after Wednesday’s FOMC when Powell said that “downside risks to the labor market are real”, we got a series of data that seemingly proved his foresight:

• Thursday, initial unemployment claims increased by 14,000 to 249,000 in the week ended July 27 (+28% since January) while continuing claims rose by 33,000 to 1.88 million in the week ended July 20 (+8.6%).
• The same day, the widely followed ISM Manufacturing PMI declined to 46.8 in July from  48.5 with generally weak details, particularly the following observations:

Eighty-six percent of manufacturing gross domestic product (GDP) contracted in July, up from 62 percent in June. More concerning: The share of sector GDP registering a composite PMI calculation at or below 45 percent (a good barometer of overall manufacturing weakness) was 53 percent in July, 39 percentage points higher than the 14 percent reported in June. Notably, all six of the largest manufacturing industries — Machinery; Transportation Equipment; Fabricated Metal Products; Food, Beverage & Tobacco Products; Chemical Products; and Computer & Electronic Products — contracted in July.

• S&P Global’s own manufacturing PMI survey also came in weak, down 2 points to 49.6, with the also depressing comments that “new business decreased solidly, and at the fastest pace in 2024 so far. Firms reported a general slowdown in market demand (…)”.
• And Friday’s employment report confirmed that “downside risks to the labor market are real”, spooking investors to the delight of the few remaining hard-landers out there.

That bad?

Ed Yardeni blames

much of the weakness on the weather. Yes, we know, the Bureau of Labor Statistics (BLS) noted that Hurricane Beryl had no impact on the report. Yet, the BLS household employment survey showed that 1.54 million workers were either not working or only part time due to weather, far above the historical average.

Workers on temporary layoff jumped to 14.8% of total unemployment, a two-year high.
Many of these temporary layoffs showed up in the initial unemployment claims in Texas. We expect both series to revert lower in August.

Goldman Sachs estimates that

underlying trend job growth based on payroll and household employment growth remains near 150k—still in line with our estimate of the go-forward breakeven rate now that immigration is slowing. (…) more than 70% of the increase [in the unemployment rate] in July came from temporary layoffs. Whether or not they were related to Hurricane Beryl, temporary layoffs might reverse in coming months and historically have not been a good recession predictor.

Claims, a BLS seasonally adjusted series, are following a summer mini-seasonality, displaying no worsening trends on a YoY basis. Furthermore, “87% of the nsa increase in continuing claims was from Texas, which is dealing with distortions from Hurricane Beryl.”

The 0.2% jump in the unemployment rate to 4.3%, from 3.5% last year, is scaring people and triggering the Sahm Rule. But all of it is caused by labor supply rising faster than demand for workers rather than outright job losses. A surge in immigration is boosting labor availability. Goldman: “Foreign-born workers once again made an outsized contribution to the increase in the unemployment rate in July, and we now estimate that recent immigrants who came to the US in the last three years have contributed 16bp of the 59bp increase in the three-month average unemployment rate since the cycle low.”

Meanwhile, job openings are still 17% above pre-pandemic levels (+14% for private employers) and have actually stabilized since March (per JOLTS data) and increased in July (per Indeed job postings, black).

Private employment growth was a low +97k in July but the 3-month average is +146k, in line with the 2019 average of +154k. In the 6 months prior to the 2008 recession, private employment growth slid from +133k to +29k per month. In 2001, it dropped from +104k to +26k per month. In 1990: from +193k to +21k.

If Ed Yardeni is right and the weather is to blame for July’s poor jobs data, aggregate labor income (employment x hours x wages) should bounce back from its zero July MoM growth in coming months.

On a YoY basis, aggregate payrolls are still rising by nearly 5% while PCE inflation has nicely slowed to the 2.5% range.

In late 2007, inflation was accelerating, quickly eroding real purchasing power…

… dragging down growth in real expenditures from +2.0% into negative territory in 6 months.

Considering current trends in employment, wages and inflation, coupled with a rather wealthy consumer, risk of a significant slowdown in consumer spending is low. Unless the dangerously boiling situation in the Middle-East erupts and boosts oil prices to levels that would choke world economies and the American consumer whose savings rate is currently historically low. WTI prices doubled to $100 in 2007.

Corporate profits are also not suggestive of meaningful budget compressions, particularly given that unit labor costs rose only 0.5% YoY in Q2 and jumped 2.7% YoY, positive for profit margins and inflation.

EARNINGS WATCH

From LSEG IBES:

376 companies in the S&P 500 Index have reported earnings for Q2 2024. Of these companies, 78.7% reported earnings above analyst expectations and 15.7% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 79% of companies beat the estimates and 16% missed estimates.

In aggregate, companies are reporting earnings that are 3.6% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 7.3%.

Of these companies, 57.4% reported revenue above analyst expectations and 42.6% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 62% of
companies beat the estimates and 38% missed estimates.

In aggregate, companies are reporting revenues that are 0.9% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.2%.

The estimated earnings growth rate for the S&P 500 for 24Q2 is 12.9%. If the energy sector is excluded, the growth rate improves to 13.9%.

The estimated revenue growth rate for the S&P 500 for 24Q2 is 5.1%. If the energy sector is excluded, the growth rate declines to 4.9%.

The estimated earnings growth rate for the S&P 500 for 24Q3 is 6.8%. If the energy sector is excluded, the growth rate improves to 8.0%.

Trailing EPS are now $231.90. Full year 2023 EPS: $243.60e. Forward EPS: $259.51e.

Note: I am travelling (Pacific time zone) until August 10. Posting will be irregular and possibly limited by time and equipment constraints.

MANUFACTURING PMIs

USA: New orders decrease for first time in three months

The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI®) fell to 49.6 in July from 51.6 in June, below the 50.0 no-change mark for the first time in seven months and signaling a slight deterioration in the health of the manufacturing sector.

Central to the worsening of overall business conditions was a first reduction in new orders for three months. New business decreased solidly, and at the fastest pace in 2024 so far. Firms reported a general slowdown in market demand, with clients often reluctant to commit to new projects at the current time. New export orders also decreased, albeit to a lesser extent than total new business. A number of respondents highlighted demand weakness in Canada.

Manufacturing production continued to rise in July, although the drop in new orders meant that the rate of expansion eased to a marginal pace that was the slowest in the current six-month sequence of growth.

Continued increases in production at a time of falling new orders meant that firms were able to work through outstanding business again in July. The rate of depletion in backlogs of work was solid and the fastest in three months. Rises in output also contributed to an increase in stocks of finished goods as some firms looked to build inventories in anticipation of future demand improvements. That said, the drop in sales was also a factor behind rising stock levels.

In act, the accumulation of post-production inventories was the strongest since November 2022 and among the fastest since the series began in May 2007.

Confidence in the future path of production also supported job creation in July, while some firms hired staff to replace previously departed workers. Employment increased for the seventh month running, but at the softest pace since January.

The positive outlook was evident in data on business sentiment, which showed optimism regaining some ground at the start of the third quarter. Hopes that the current soft patch in demand will prove temporary, with new business improving following the Presidential Election, supported confidence in the outlook for production.

Input costs increased markedly in July amid reports of higher prices for energy, freight, labor and raw materials. That said, the rate of inflation eased to a four-month low.

Meanwhile, manufacturers increased their own selling prices at only a marginal pace, with the rate of inflation easing to a one-year low as firms restricted price rises in an attempt to secure sales in a competitive market.

Purchasing activity decreased for the second month running, with firms reluctant to purchase additional inputs given falling new orders and rising prices. The modest drop in purchasing fed through to a further reduction in stocks of inputs, the fifth in as many months.

Reduced demand for inputs led some suppliers to speed up deliveries, but this was cancelled out by shortages of staff and materials, plus shipping delays. Supplier performance was therefore broadly unchanged in July.

• The ISM:

The Manufacturing PMI^® registered 46.8 percent in July, down 1.7 percentage points from the 48.5 percent recorded in June. The New Orders Index remained in contraction territory, registering 47.4 percent, 1.9 percentage points lower than the 49.3 percent recorded in June. The July reading of the Production Index (45.9 percent) is 2.6 percentage points lower than June’s figure of 48.5 percent.

The Prices Index registered 52.9 percent, up 0.8 percentage point compared to the reading of 52.1 percent in June. The Backlog of Orders Index registered 41.7 percent, equaling its June reading. The Employment Index registered 43.4 percent, down 5.9 percentage points from June’s figure of 49.3 percent. (…)

The New Export Orders Index reading of 49 percent is 0.2 percentage point higher than the 48.8 percent registered in June. The Imports Index remained in contraction territory in July, registering 48.6 percent, 0.1 percentage point higher than the 48.5 percent reported in June.”

U.S. manufacturing activity entered deeper into contraction. Demand was weak again, output declined, and inputs stayed generally accommodative. Demand slowing was reflected by the (1) New Orders Index dropping further into contraction, (2) New Export Orders Index continuing in contraction, (3) Backlog of Orders Index remaining in strong contraction territory, and (4) Customers’ Inventories Index moving lower to the higher end of ‘too low’.

Output (measured by the Production and Employment indexes) declined compared to June, with a combined 8.5-percentage point downward impact on the Manufacturing PMI calculation. Panelists’ companies reduced production levels month over month as head-count reductions continued in July. Inputs — defined as supplier deliveries, inventories, prices and imports — generally continued to accommodate future demand growth.

Demand remains subdued, as companies show an unwillingness to invest in capital and inventory due to current federal monetary policy and other conditions. Production execution was down compared to June, likely adding to revenue declines, putting additional pressure on profitability. Suppliers continue to have capacity, with lead times improving and shortages not as severe.

Eighty-six percent of manufacturing gross domestic product (GDP) contracted in July, up from 62 percent in June. More concerning: The share of sector GDP registering a composite PMI^® calculation at or below 45 percent (a good barometer of overall manufacturing weakness) was 53 percent in July, 39 percentage points higher than the 14 percent reported in June. Notably, all six of the largest manufacturing industries — Machinery; Transportation Equipment; Fabricated Metal Products; Food, Beverage & Tobacco Products; Chemical Products; and Computer & Electronic Products — contracted in July.

The five manufacturing industries reporting growth in July are: Printing & Related Support Activities; Petroleum & Coal Products; Miscellaneous Manufacturing; Furniture & Related Products; and Nonmetallic Mineral Products. The 11 industries reporting contraction in July — in the following order — are: Primary Metals; Plastics & Rubber Products; Machinery; Electrical Equipment, Appliances & Components; Transportation Equipment; Fabricated Metal Products; Food, Beverage & Tobacco Products; Wood Products; Paper Products; Chemical Products; and Computer & Electronic Products.

Eurozone factory output contracts at strongest rate in 2024 so far

The HCOB Eurozone Manufacturing PMI, a measure of the overall health of eurozone factories and compiled by S&P Global, matched that seen in June, recording 45.8 once again in July. Subsequently, this represented a further marked deterioration in the health of the euro area’s goods-producing economy.

Albeit unchanged on the month, most of the eight monitored eurozone nations saw Manufacturing PMI figures decrease when compared to June. Germany and France, the currency bloc’s two largest economies, saw their respective index values drop to three- and six-month lows, respectively. Greece and Spain, which have been the two strongest performers in 2024 so far, also lost growth momentum. Italy and Ireland were the only two countries covered by the survey to see their Manufacturing PMI increase.

For the eurozone as a whole, July survey data indicated a slight acceleration in the factory order downturn that has been ongoing since May 2022. Overall, the pace of contraction was the quickest in three months. Cross-border sales activity also weighed on demand for eurozone goods at the start of the third quarter, as evidenced by another solid reduction in new orders from export markets*.

To compensate for lower workloads, eurozone manufacturers leaned more heavily on their backlogs as a means to support production. Outstanding business volumes were depleted at a sharp and quicker rate in July. In fact, the pace of depletion was the fastest since February. Nevertheless, production levels suffered the most marked contraction in the year-to-date.

Net factory employment fell at the start of the third quarter, with workforce numbers decreasing at the fastest pace since last December. This stretched the current sequence of job shedding to 14 months. Lower staffing capacity coincided with a drop in business confidence, the first time since October last year this has been the case. Overall, expectations for output in the coming year slipped to a four-month low.

Eurozone manufacturers trimmed their purchasing activity in July, albeit to a slightly softer extent than in June. Still, the rate of decline was sharp. In turn, pre-production inventories were reduced for the eighteenth month in a row. The latest survey data signalled a further improvement in supplier performance, but the extent to which delivery times shortened was the weakest in six months.

Lastly, HCOB PMI data revealed another monthly increase in eurozone manufacturers’ operating costs. The rate of input price inflation quickened to a one-and-a-half-year high, but remained below the long-run trend. Charges for goods leaving the factory gate were broadly unchanged since June, indicating that firms refrained from passing on higher cost burdens to their clients.

CHINA: Operating conditions deteriorate amid a renewed fall in new orders

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI®) fell to 49.8 in July, down from 51.8 in June. Easing below the 50.0 neutral mark, the latest data signalled that conditions in the manufacturing sector deteriorated for the first time in nine
months, albeit only marginally.

Manufacturing output expansion was the slowest in the nine-month sequence during July, attributed to the first fall in new orders for a year. According to panellists, subdued demand conditions and reductions in client budgets underpinned the latest fall in new work. Export orders meanwhile continued to rise, but the rate of growth slowed from June to a modest pace.

Sub-sector data revealed that reductions in new orders mainly unfolded in the investment and intermediate goods segments while the consumer goods sector expanded slightly in July. (…)

Employment levels remained relatively stable, falling only fractionally in July. While some firms added headcounts to cope with ongoing workloads, others opted to reduce staffing levels, anticipating lower production needs as new orders fell.

Turning to prices, average selling prices declined for the first time since May. Chinese manufacturers indicated reducing selling prices to support sales amid Increased competition. This was partially supported by input cost inflation easing to the lowest in the current four-month sequence.

Renewed contraction in Japan’s manufacturing sector

The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI®) fell from the neutral 50.0 mark in June to 49.1 in July to signal a deterioration in the health of the sector for the first time since April. The reduction was modest, yet the strongest seen for four months.

There was a sustained contraction in new orders at the start of the third quarter of 2024. The pace of decline quickened from June, and was the sharpest for four months. According to panellists, demand from both domestic and international markets was subdued.

Also contributing to the sub-50.0 PMI reading was a renewed contraction in output levels in July. The downturn reportedly reflected production adjustments in response to weaker demand, though was only fractional overall. Muted customer demand allowed firms to work through existing orders, as signalled by a stronger fall in backlogs of work. Moreover, the rate of depletion was the fastest since March and sharp overall.

Firms often indicated they kept on top of capacity requirements to complete outstanding business, as indicated by a fifth consecutive increase in employment levels.

On the prices front, input cost pressures intensified in the latest survey period. Average cost burdens rose at a marked rate that was the strongest since April 2023. Higher operating expenses were often attributed to increased labour, logistics, oil and raw material
prices. Output price inflation meanwhile remained steep but eased to a four-month low as firms attempted to remain competitive. (…)

Powell means September, whatever he doesn’t say

(…) Powell did this by saying that “the sense of the committee is closer to cuts but we’re not there yet,” by freely conceding that “downside risks to the labor market are real,” while adding that employment is “not a source of material inflationary pressure,” by calling policy “restrictive, not extremely restrictive but restrictive,” and by cheerfully describing the latest inflation data as “so much better” than 12 months ago. A cut will happen at the next meeting if inflation moves down “in line with expectations,” which is a way of saying that we should expect a cut. (…)

The greatest risk confronting the Fed now would be an unpleasant surprise Friday from the payrolls data for July. Powell made clear that unemployment was now as much of a concern as inflation, but also said that the jobs market was merely “normalizing” rather than moving steadily toward a recession. (…)

Business Confidence for Small and Large Firms

Since the Fed started raising rates, business confidence has diverged for small and large companies.

The source of the divergence is likely higher costs of capital for small companies that have higher leverage and lower coverage ratios, and lack access to broadly syndicated loan markets and private credit.

In other words, the transmission mechanism of tighter monetary policy mainly works through smaller companies that are harder hit by Fed hikes and don’t benefit from tighter credit spreads and higher stock prices.