Early August: Market Volatility and Rate Cut Expectations Soar on “Weak” Jobs Report…Now: Market Calm Resets Expectations…What’s Next?
The August 2 release of July’s jobs report sent markets into a tailspin. According to the report, employment increased by 114,000 (below the 12 months average of 215,000 and below the consensus of 175,000). The unemployment rate edged up to 4.3%, the highest since October 2021. The jobs report stoked recession fears in the U.S. The Volatility index (VIX) hit levels last seen during the early days of the 2020 pandemic shutdown and the 2008 Lehman crash. The weak unemployment report acted as a catalyst to unleash a worldwide selling of assets. Treasury yields plummeted as the 10-year dropped from 4.10% to 3.75% in one day. The Dow lost over 1,000 points and the Japanese Nikkei plunged 12.4%. The jobs report coincided with the Bank of Japan’s central bank head commenting on a planned rate increase (long anticipated but the timing shook markets). Fear of the increase led to a massive unwinding of the “carry trade” whereby investors borrow in yen at low rates and invest in investments denominated in currencies paying higher rates (in the US, Europe, Mexico, etc). The size of the yen-dollar carry trade is estimated to be over $1 trillion. Markets then hope (or count on) the “old reliable” aka the “Fed put” to save the day: the belief that the Fed will step in with accommodative monetary policy to buoy markets, specifically the U.S. equity market, if prices fall too fast too quickly. Expectations of a September rate cut soared with futures markets and prominent analysts calling for a 50-basis point cut. Many were anticipating an ultra-rare intra-meeting cut (remember Powell’s March 2020 Sunday morning “rates are zero” announcement). Futures markets indicated a 70% chance of a 50 bp cut in September and a total of 1.50% in rate cuts by the end of the year.
That was two weeks ago. Markets calmed as the BOJ issued a rare retraction and pledged not to raise rates during market instability. Carry trade and currency imbalance volatility is most likely not over – look for the Fed and BOJ to possibly coordinate actions in the coming months. Subsequent US economic reports alleviated recession fears (lower than expected jobless claims, higher than expected retail sales). Interestingly, 59% of Americans believe a recession has started. Stock markets recovered and the 10-year Treasury now stands at 3.90%.
Sahm rule invoked – the high unemployment rate has triggered the “Sahm rule”, an early indicator of recessions. However, Claudia Sahm herself has said that “this time” it does not necessarily mean a recession is imminent. Sahm pointed out that other economic indicators, such as consumer spending and job gains, suggest that the U.S. economy continues to expand. Again, it seems that this extended economic cycle triggered by the pandemic crash and subsequent market disfunction, massive stimulus, etc is a unique situation whereby the old rules may not apply. Rate cut expectations have been pared back. Look for Fed Chair Powell to lay the groundwork for a September cut at his speech during the annual Jackson Hole Symposium at the end of August. Fed futures indicate a 73% change of a 25 bp cut with 27% at 50 bps and 75-100 bps by year end. Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners.