A New Landscape
By Dr. Charles Lieberman, Co-founder & Chief Investment Officer
Key Takeaways:
- Sharp Downward Job Revisions Indicate a Weaker Labor Market: While July’s job gains were moderate, revisions to May and June showed significant weakness, challenging the perception of a strong labor market.
- Fed Rate Cuts Are Increasingly Likely: Weakening employment data and uncertainty from tariffs are building the case for rate reductions, potentially as early as September.
- Stagflation Concerns Emerging: Slower growth combined with tariff-driven inflation may revive fears of stagflation, complicating the Fed’s path forward.
- Investment Implications Favor Bonds and Rate-Sensitive Sectors: Falling yields enhance the appeal of fixed income, while lower rates should also boost housing and provide support for equities.
The moderate rise of 73,000 new hires in July in Friday’s jobs report was not bad, but the downward revision to the prior two months was shockingly awful, especially as other labor market reports remained solid. There’s still no recession in sight, although slower growth is now obvious. And Fed rate reductions are coming to defend against any risk of recession.
The reasonable job growth reported for July did little to make up for the massive downward revisions to May and June by a combined 258,000 positions. The Bureau now sees just 33,000 jobs added in total in those two months combined, dramatically changing everyone’s perspective on employment growth. What was seen as strong is now clearly weak. The data also show that the foreign-born workforce declined by 452,000 over the past year, which we had been expecting based on the Administration’s immigration policies, which hadn’t been evident before. Over the same period, the native-born workforce grew by 2.4 million. So, while job growth is now seen as much slower, labor force growth has also slowed, keeping the unemployment rate unchanged at 4.2% for the past year.
Job growth may remain soft in the months immediately ahead. Government employment was notably weak, as the DOGE job cuts are now apparent in the revised data, and we know there are more yet to show. More broadly, the on-again, off-again, changing tariffs added considerable uncertainty to economic conditions, so businesses held back hiring and businesses and households also cut back spending. This makes a strong case for the Fed to ease policy to reduce the risk of this slowdown from gathering momentum to the downside and pushing the economy into a recession. Powell’s public statements last week gave the markets little reason to expect rate cuts anytime soon, but it is a safe bet he’ll be whistling a different tune after the labor market report. We expect a radically different tone by the time of the Fed’s Jackson Hole conference at the end of the month.
So, what lies ahead, aside from plenty of uncertainty? Inflation isn’t likely to slow much, if at all, due to the tariff increases finding their way into prices, despite the slower-growing economy. Expect to hear a lot about stagflation. Trump will surely be highly critical of the Fed for not lowering rates and now he will be able to point to the job slowdown. He will also be able to name a replacement for Adriana Kugler, who just announced her resignation from the Fed Board. (I would turn that job down if it were offered to me, as I noted on the most recent ACM 10-second show.) But I would expect Powell to support a rate cut at the September meeting, possibly even a 50-basis point cut, depending on incoming data.
As for the markets, interest rates should remain under some downward pressure, despite the large declines on Friday. Fixed-income investments are suddenly substantially more attractive now. In a slowly growing economy, there would be little risk that higher tariff costs would promote a rise in inflation across the economy. And there is a better case to be made, at least for the moment, to buttress growth by lowering rates, which will support bond prices.
The outlook for stocks depends on the performance of the economy. Recession risks are not yet high. Wage inflation of around 4% with price inflation of around 2.5% implies solid growth in real disposable income. So, households have the capacity to spend. Lower oil prices will also reinforce household finances. Businesses, the other key player in the economy, have the incentive to invest domestically, with tariffs improving returns on domestic investment and AI forcing firms to adapt or risk being overtaken by competitors. And lower rates will lead to a quick positive reaction in the housing sector. As long as the economy can sustain a moderate, or even a modest, level of growth, stocks should hold up. And if the Fed cuts rates and yields decline, as is now likely, lower discount rates will provide additional support for stocks. We will keep watching closely to see if the economy remains on this track.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.