Capital markets perspective: The list goes on

Capital markets perspective: Taking note


So far in this cycle, the U.S. economy has dodged a recession.

But the list of classic economic indicators that suggest the U.S. economy could have tipped over by now is a long one: a deeply inverted yield curve, a widening gap between leading and coincident indicators, extremely tight bank lending standards, an on-again/off-again recession flag from the Conference Board’s dedicated recession model, tight housing, underwater Purchasing Manager’s Indices and downbeat regional Fed manufacturing reports.

The list goes on.

That’s without even mentioning the 5.25% in Fed rate tightening itself. We’ve talked about each of the recession-suggestive indicators extensively in turn. But now, fast-forward to last week and the list grew longer still: On Friday, the Chicago Institute for Purchasing Managers released its latest update of the Chicago Business BarometerTM, a 70-year-old survey designed to triangulate trends in the national economy each month by assessing buying conditions and asking its members a series of questions regarding business trends facing their specific firms.1 While it's not really accurate to describe last week’s reading of 35.4 as a recessionary signal in and of itself, a review of historical data hints at the notion that the index is almost never that low without an accompanying recession.

And yet still: no recession. How can that be? The path connecting Fed tightening to a recession is always long and uncertain – owing, in large part, to what Fed Chairman Jerome Powell has described as the “long and variable lags” between when monetary policy is implemented and when its impacts actually flow through into the economy. Beyond that, it’s not much of a logical leap to assume that the economic distortions caused by the COVID-19 pandemic and the unprecedented economic stimulus that followed served to lengthen those lags by bestowing consumers with more spending power than they would have had on the eve of a rate-hike cycle, or that COVID has fundamentally altered the nation’s economic psychology. That may in turn have allowed not only spending, but also hiring to remain higher-for-longer (recognize the phrase?) than they ordinarily might have in the face of tightening, thereby helping keep the economy out of recession even after other vital signs have started flashing red.

Are these two things enough to claim that the U.S. economy is not headed toward recession? So far, that seems to be the case. But I, for one, am not yet fully convinced that there isn’t still a reckoning to be had. This leg of the economic cycle recently notched its 48th month of post-pandemic growth, though the economy does appear to be slowing.

Wednesday’s release of the Federal Reserve’s Beige Book showed that, of 12 Fed district banks polled, 11 described growth as “flat,” “slight,” “modest,” or some derivation thereof.2 Only one – Kansas City – expressed more than that: Growth there was characterized as “moderate.” While it’s obviously a good sign that no single Fed district observed a decline in growth, there were nonetheless a few ominous signals buried deep in the anecdotes. Here’s a sample: “Employee turnover has decreased,” and “employers’ bargaining power has increased.” If one of the things that has kept the U.S. out of recession so far is the unusual post-COVID durability of labor markets, then these vignettes suggest that may be coming to an end. Particularly noteworthy is the comment on turnover, which suggests current employees are no longer as comfortable walking away from a paying gig as they have been in the recent past. That has historically been a turning point for labor markets (and something that finds its most explicit expression in the so-called “quits rate,” due out this Tuesday as part of the Bureau of Labor Statistics’ JOLTS report).

Meanwhile, here’s what the Beige Book had to say about consumers and the businesses that serve them: “Consumers are starting to push back on price increases, which led to smaller profit margins as input prices rose on average.” There are at least two things embedded in that sentence that are worth mentioning. First, the Fed is indicating that inflation is (finally) dampening consumer demand. If that’s truly the case, then one of the last supports shoring up the economy may be slipping. Precisely on cue, the Bureau of Economic Analysis seemed to corroborate that idea on Friday by reporting that real, inflation-adjusted consumer spending declined slightly in April – something that has only happened a handful of times since the COVID recession ended in early 2020.3 By contrast, economists had expected real spending to increase slightly.

Maybe it shouldn’t be surprising, then, that the second estimate of first-quarter GDP was taken down from the 1.6% to 1.3%, primarily because consumer spending was found to be a little less robust during the first three months of 2024 than originally thought. For those keeping score, that brings the number of months with slower-than-hoped-for spending growth so far in 2024 to four out of four.4

Meanwhile, corporate profits – which find their way into the Gross Domestic Product figures only with the first revision – also took a hit. To my mind, that’s even more troubling than a long-awaited resetting in consumer demand because it suggests that corporate earnings may be about to get pinched. That matters, because current equity market valuations only make sense if corporate earnings continue to surge. 

It goes without saying that the torrid pace of consumer spending and the tightness of the U.S. labor market during the early phase of the post-pandemic recovery were both unsustainable: The labor market had to cool, and consumers had to back off. That, after all, is exactly why the Fed began its tightening campaign in the first place – to cool things off before they overheated. And in at least one way, that makes last week’s data marginally reassuring; one of the upbeat bits in last week’s data was word that the Fed’s preferred gauge of inflation – the Core Personal Consumption Expenditures Price Index – was relatively tame.

But once spending starts to decline or labor markets start to weaken, the slowdown can sometimes gather momentum of its own. And that can ultimately change a soft patch from “benign slowdown” to “outright recession.” That means we are now once again standing at a critical junction for investors who now must sort through the myriad recession signals to decide which is a true false positive, and which just started flashing too soon.

What to watch this week

It’s payrolls week, a monthly dive into the details of the labor market that always generates massive interest – doubly so when the jobs market is so central to the overall narrative as it is now. The fun begins on Tuesday with the Bureau of Labor Statistics’ closely watched Job Openings and Labor Turnover Survey (JOLTS) report, the highlight of which this time around might well be the “quits rate,” commonly viewed as an important indication of confidence among wage-earners. As mentioned above, last week’s Fed minutes hinted strongly that confidence is waning, and JOLTS data – while a little stale – will represent an important cross-check of that conclusion.

Next up is Wednesday’s payrolls estimate and pay insights survey from payroll processor ADP. This release always sets the tone for the week by providing a sneak peak of how Friday’s official payrolls estimate from the Bureau of Labor Statistics might ultimately look, but I’d pay even closer attention to ADP’s accompanying Pay Insights report. This data, which only recently has earned a spot in the starting rotation of macro-related data, contains information relevant to both job growth and inflation – two critical reads that economists will parse with interest given the realities of today’s environment.

Then on Thursday, outplacement firm Challenger, Gray & Christmas will release its monthly tally of layoff announcements. As with all labor data, the best possible scenario would be data that suggests the labor market is cooling just enough to keep wage growth (and therefore inflation) under control while not hinting at a pending collapse in jobs. So far, Challenger’s data has been generally supportive of that conclusion even as layoff announcements have tracked higher. Let’s hope that continues.

Finally, Friday’s non-farm payroll data is perhaps the biggest and most closely followed macro release every month. It contains an estimate of the number of U.S. workers added to (or subtracted from) U.S. payrolls, the overall unemployment rate, labor force participation, hours worked, and all sorts of other stuff that may not be immediately market-moving but is still fascinating and can be important in creating a comprehensive view of the labor market. For example, those who want to look beyond the headlines might be interested in how many U.S. employees are working part-time for economic reasons, or the percentage of the workforce who considers themselves to be underemployed, or the use of temporary employees, which can serve as an early warning system for labor trends more broadly.

In terms of single-event risk, Thursday’s rates decision by the European Central Bank is worth mentioning. The ECB is similar in influence and scope to our own Federal Reserve and carries massive influence both in Europe and across the globe. President Christine LaGarde, a peer to Fed Chair Jerome Powell, has been signaling a rate cut for weeks and markets have priced rates accordingly. If she delivers, it will inevitably invite discussion surrounding when the Fed might follow suit. But if the ECB fails to deliver at least a quarter-point cut on Thursday it’s reasonable to expect significant volatility in European markets toward the end of this week. Watch also for updated estimates of European inflation and signals regarding whether this week’s expected cut would be the first in a series, or more “one-and-done” for now.

Finally, with recession fears creeping their way back into the discussion, this week’s Purchasing Managers Index and Institute of Supply Management data is probably worth an even closer look than usual. These surveys tend to be more forward-looking than other macroeconomic releases and have recently been somewhat volatile. Results for the smaller (but cyclically important) manufacturing sector are due out Monday, while the data relevant to the much larger services sector will arrive Thursday.

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Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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