The Economy
The Wait Isn’t Over, At Least Not For Us
October 2024
In last month’s edition, we noted that it would take some time to know whether the pace of economic activity is finally normalizing after the significant disruptions/distortions brought about by the pandemic and the policy response to it, as we believe to be the case, or whether something less benign is underway and will end in recession. The body of economic data released since then seems to suggest that the wait for the answer to that question wasn’t so long after all, with generally stronger than expected data pointing to further normalization, if not reacceleration, in the pace of economic activity. We do not, however, think the recent run of seemingly solid data settles anything. To be sure, our premise remains the same, i.e., that the economy is normalizing back toward the trend rate of growth that prevailed over the decade prior to the onset of the pandemic. We simply think it far too soon to have a definitive answer.
The third estimate from the Bureau of Economic Analysis (BEA) shows real GDP grew at an annual rate of 3.0 percent during Q2, but the bigger news here is that the BEA’s third estimate of Q2 GDP incorporated the results of their annual revisions to the recent historical data. The revised data show faster growth in both real GDP and real Gross Domestic Income (GDI) over the period from Q1 2019 through Q2 2024 than had previously been reported. For instance, real GDP is now reported to have grown by 2.5 percent in 2022 and by 2.9 percent in 2023, compared to prior estimates of 1.9 percent and 2.5 percent growth, respectively. The upward revision to real GDI was even larger, with growth in both personal income and corporate profits revised meaningfully higher.
At first glance, the September employment report would seem to allay concerns over the state of the labor market and the broader economy. Total nonfarm payrolls rose by 254,000 jobs in September, while prior estimates of job growth in July and August were revised up by a net 72,000 jobs for the two-month period, and September job growth was broadly based across private sector industry groups. At the same time, the unemployment rate fell to 4.1 percent. Indeed, in the wake of the release of the September employment report, some analysts went so far as to argue that the FOMC had made a mistake by cutting the Fed funds rate by fifty basis points at their September meeting and, as such, should keep the funds rate unchanged at their November meeting. And to think, it was only two months ago that, in the wake of a surprisingly weak July employment, many took to the airwaves to call for “emergency” Fed funds rate cuts on the order of fifty or seventy-five basis points.
As for us, we reacted to the September employment report as we react to each and every data release, which is to go to the details of the data to try and put the headline numbers into proper context. For openers, continuing a pattern that has plagued the employment reports since the onset of the pandemic, the initial collection to the BLS’s September establishment survey was 62.2 percent, the lowest rate for the month of September since 2002. As we have been noting for far too long, these low collection rates lay a path for sizable revisions, either in subsequent months or in the annual benchmark revision process. Additionally, the upward revisions to prior estimates of job growth in July and August mainly reflect upward revisions in the education segments of state and local governments, reflecting the difficulty in adjusting the data to account for changes in the timing of the school year from one calendar year to the next.
To us, however, the much bigger issue is that the September data are riddled with seasonal adjustment noise, which flattered the headline job growth number. In our preview of the September employment report, we noted that we thought there would be strong seasonal adjustment effects stemming from what we expected would be a smaller than normal September decline in private sector payrolls. We pointed to construction, retail trade, and leisure and hospitality services as potential sources of seasonal adjustment noise. That proved to be the case, with leisure and hospitality services the most obvious instance. The unadjusted data show payrolls in leisure and hospitality services fell by 471,000 jobs, a hefty decline to be sure but in percentage change terms this was smaller than the typical September decline. As such, the seasonally adjusted data show payrolls in this industry group rose by 78,000 jobs. We can point to similar, albeit smaller, effects in both construction and retail trade.
The reported decline in the unemployment rate is also a gift from seasonal adjustment. The entire increase in the labor force and nearly all of the increase in household employment in September are accounted for by those in the 16-to-24 year-old age cohort. This reflects nothing more than the not seasonally adjusted data showing much smaller than normal September outflows, which in turn are the flip side of much larger than normal August outflows, amongst this age cohort. This is merely another illustration of how changes in the timing of the school year from one year to the next can confound the seasonal adjustment process.
The one-month hiring diffusion index, a gauge of the breadth of hiring across private sector industry groups, rose to 57.6 percent in September, the highest reading since January. The diffusion index, however, measures the breadth, not the intensity, of hiring. In other words, though most industry groups continue to add jobs, they are doing so at a slower rate, and job growth remains highly concentrated amongst three industry groups – leisure and hospitality services, government, and health care. Through September, these three industry groups accounted for just over seventy percent of all nonfarm job growth in 2024. At some point, the pace of hiring in these industry groups will slow, which will have an outsized impact on overall job growth.
To the extent there is such a thing, we see the “truth” about labor market conditions as being somewhere between the July and September employment reports. More specifically, we think it is clear that the trend rate of job growth is slowing, but the weekly data on initial claims for unemployment insurance and the data from the Job Openings and Labor Turnover Survey (JOLTS) tell us that this remains a function of a slowing pace of hiring as opposed to a rising pace of layoffs. While the slowing pace of hiring has put some upward pressure on the unemployment rate, the bigger driver of the increase in the unemployment rate over the past several months has been notably rapid growth in the labor force, growth which at some point we expect to slow.
Further cooling in the labor market is consistent with what we expect will be a pronounced slowdown in real GDP growth over the back half of 2024 extending into 2025. Growth in consumer spending is clearly slowing; while overall financial conditions in the household sector remain solid, lower-to-middle income households continue to feel financial stress from the cumulative effects of elevated inflation over the past few years. Moreover, the Conference Board’s monthly survey of consumer confidence shows consumers taking an increasingly less favorable view of labor market conditions, which is likely weighing on discretionary spending amongst a broader range of households.
While the Institute for Supply Management’s (ISM) Non-Manufacturing Index rose to 54.9 percent in September, the highest reading since February 2023 and suggesting continued expansion in the broad services sector, the ISM Manufacturing Index remains mired below the 50.0 percent break between contraction and expansion. Uncertainty over the outlook for fiscal, trade, and regulatory policy is contributing to malaise in the manufacturing sector, with many businesses having put capital spending plans on hold until there is some clarity on the policy front. This will limit the contribution from business fixed investment to real GDP growth over the next few quarters.
Even with real GDP growth slowing and the labor market cooling, inflation is not going away quietly. The prices paid index from the ISM Non-Manufacturing Index continues to show steady, and broadly based, increases in prices for non-labor inputs across the services sector. At the same time, should the recent increases in crude oil prices in response to ongoing tensions in the Middle East stick, let alone intensify, the recent run of falling retail gasoline prices will likely reverse, meaning energy would contribute to headline inflation after having been a net drag over recent months.
In short, the paths of economic growth, the labor market, and inflation are far from clear, further complicating the FOMC’s efforts to properly calibrate monetary policy. As we noted last month, it seems that each and every economic data release is being interpreted as though it provides definitive evidence of where the economy is heading. Given the mixed signals being sent by the various data releases, this is contributing to volatility in the equity and fixed income markets as well as rapidly shifting expectations around the path of monetary policy. This is something that may not change any time soon.
Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; Institute for Supply Management; The Conference Board
As of October 9, 2024
