In markets and economics, you sometimes have to hold two thoughts in your head simultaneously—an important lesson now that the US unemployment rate has surged to its highest in nearly three years.
First, the labour market probably isn’t quite as imperilled as the main figure suggests. Second, the speed at which it’s cooling ratchets up risks, and the Federal Reserve should entertain the possibility that it’ll need to cut rates by 0.5 percentage point in September.
A report showed that the joblessness rate rose to 4.3% in July from 4.1% the previous month, exceeding economists’ estimates. That’s still relatively low, but the speed of its rise over the past four months is a worry.
A rule developed by Claudia Sahm shows that historically, the economy is already in a recession once the three-month average of the unemployment rate rises at least a half percentage point above its low in the past 12 months. That has happened.
The US labour market is cooling down at a pace that must leave monetary policymakers uncertain as to where things will stand in September, when they meet next.
Non-farm payrolls still rose by 114,000 last month, but jobs need to grow by a modest amount just to keep pace with population and labour force growth. The payrolls figure was down from a revised 179,000 a month earlier.
In an economy in which labour market weakness tends to snowball, Fed policymakers surely must be on high alert after the latest statistics. Even modest upticks in unemployment can lead to reduced consumption, which can lead to weakness elsewhere in the economy. That’s in part the intuition of the Sahm Rule, and it demands that policymakers always act in a forward-looking manner.
Having said that, there’s probably some overreaction in the market following the report. The S&P 500 Index fell and the yield on 10-year Treasury notes dropped 16 basis points to 3.82%.
These are pre-recessionary market dynamics, though there’s nothing in the numbers that come close to confirming a downturn. Let’s keep things in context: The US GDP grew at an annualized pace of 2.8% in the second quarter.
Additionally, there are—as always— plenty of conflicting narratives and sources of potential noise under the surface in the labour market data itself.
The weak data comes at a time when Hurricane Beryl struck Texas during the reference period. In its report, the Bureau of Labor Statistics wrote that it had “no discernible effect” on the data, but there was a large increase in the number of people reporting that they didn’t work due to bad weather.
There was also a large increase in temporary layoffs, but less movement in permanent layoffs, as Burning Glass Institute Director of Economic Research Guy Berger pointed out on X. Given the hurricane impact, that seems like an important point.
In previous months, the uptick in unemployment had come from an increase in labour supply; job market entrants and re-entrants who don’t immediately find work raise the unemployment rate.
As for the Sahm Rule, even Claudia herself has repeatedly emphasized that it’s not a law of nature and that this time could be different. “That comes off of historical experience; that doesn’t necessarily tell us where we are right at this moment,” she told Bloomberg Radio’s Tom Keene and Damian Sassower last week. Still, she was concerned about “way too much momentum in the unemployment rate.”
Personally, I had been pounding the table for a rate cut earlier this week, much like my Bloomberg Opinion colleague Bill Dudley, the president of the Federal Reserve Bank of New York from 2009 to 2018.
Even though I didn’t see an imminent downturn, I simply thought it was the better risk-management move. Having missed that opportunity, policymakers may have to hurry to ease rates when they meet again in September if further data confirms the recent trend.
Despite their inaction last week, policymakers are clearly aware of the risks and just needed a bit more convincing. In his press conference, Fed Chair Jerome Powell was asked explicitly, by Jean Yung of MNI Market News, about the possibility of a 50-basis-point cut.
Although he reflexively pushed back at the notion, he wisely edited himself in real time to leave the door open. “I don’t want to be really specific about what we’re going to do, but that’s not something we’re thinking about right now,” Powell said, before adding: “Of course, we haven’t made any decisions at all as of today.”
Nor is it likely that they have made any decisions after the latest jobs report. But fortunately, they have a lot of monetary policy firepower at their disposal with rates at a two-decade high of 5.25%-5.5%. They should prepare to use it. ©bloomberg
