Quite an eventful week! The July employment report on Friday sent a shockwave through financial markets. The highly anticipated unemployment rate logged 4.3% vs. consensus of 4.1%. July’s reading represents a 90-bps increase from the cycle low of 3.4% in April 2023. Furthermore, July’s unemployment rate triggered the Sahm Rule, a very reliable recession indicator based on the 3-month moving average of the unemployment rate.

Why is this important? Markets were (and are) not priced for a rapidly deteriorating U.S. employment market. This is evidenced not only by the unemployment rate, but also the employment component of leading economic indicators and trends in jobless claims. While we have been writing about this labor market dynamic for some time, consensus has generally focused on the decline in inflation indicators and the expectation of interest rate cuts to bid up equities.

Considering the weakening data, investors sold stocks late last week on the premise that the Federal Reserve is indeed behind the curve on reducing its policy rate. Fed funds futures now imply expectations of more than one interest rate cut by the September meeting and more than three cuts by the November meeting.

Investors tend to believe that a shift to accommodative monetary policy will immediately stave off further deterioration in the labor market. Unfortunately, policy works with a significant lag time. It takes roughly two years for changes in policy to be reflected in labor markets. The chart we show here is the fed funds rate advanced 24 months against the unemployment rate. The flow through of the Fed’s 2022-2023 hiking cycle is just beginning to ripple through the employment market thereby triggering the Sahm Rule and raising the risk of recession … right on schedule.

The Macro Week Ahead

The Macro Week In Review

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