Another Jobs Report, Another Disappointment
By Dr. Charles Lieberman, Co-founder and CIO
August payroll employment came in weaker than expected with just 142,000 net new hires, but the prior two months were revised lower, so we now average only 116,000 new jobs over the last three months. Investors were already nervous that a recession might be imminent and they were certain the Fed would lower interest rates at its upcoming September meeting, but the debate has now shifted to whether they will go by 25 or 50 basis points. We would love to be inside that meeting, since it is sure to be a lively discussion. But we still expect just 25. And the economy will be fine.
Economic growth remains solid, in our judgment, even if the pace has moderated. Indeed, it was to temper the pace of economic growth that led the Fed to hike rates for a while. In Q2, GDP was 3.0% after 1.4% in Q1 for a 2.2% average. Job growth over the latest three months, while reduced, and somewhat understated, is still running at a 0.9% annual rate. Adjusting for productivity would add at least another full percentage point to GDP growth. And the Atlanta Fed is currently estimating Q3 GDP growth at 2.1%. All of that is very solid and fairly steady.
Unemployment has behaved a bit abnormally amid this growth. At 4.2%, it has increased significantly from its low around 3.4%, even though it remains historically low. But the driving force behind the increase appears to be the influx of immigrants, both legal and illegal, not job losses. Since 2020, legal and illegal immigration has added over 9 million to our population, roughly 2.5 million at an annual rate. Over the past 12 months, the foreign-born workforce rose by 2.0 million, while the native-born workforce fell by nearly 400,000. In the latest two months, the workforce surged by 420,000 in July and another 120,000 in August. Despite the surge in the labor force and the rise in unemployment, initial unemployment claims continue to fluctuate at a low weekly level of around 230,000. With a moderation in the rate of job growth, the influx of immigrants has pushed up unemployment.
Immigrants, especially illegal immigrants, tend to have less education. The unemployment rate for those without a high school diploma rose from 5.4% to 7.1% over the past year, while those with some college or a college degree rose from 2.5% to 2.8%. So, the influx of immigrants is increasing the supply of labor, and this has produced a rise in unemployment, but mostly for the least educated within our labor force. At the same time, the rise in labor availability has also enabled growth to continue, since labor scarcity has not been an inhibiting factor to growth.
In our judgment, the risk of recession remains low, market fears notwithstanding. Investors have been anticipating a recession for more than two years, as reflected by the inverted yield curve, so most people now recognize that signal as having been wrong. As we entered 2024, markets were priced for almost seven 0.25% rate cuts, almost one 25 basis point cut per Fed meeting. By summer, with no recession in sight, markets repriced for almost zero cuts by yearend. But within the past several weeks, the markets have repriced yet again for almost five 0.25% cuts by the end of this year! Since there are only three Fed meetings scheduled, investors expect cuts at every meeting, more often 50 basis points rather than 25. It is hard to imagine such a large decrease in policy rates within such a short period of time without an immediate recession. Many have criticized the Fed for not being good at forecasting the economy, but it appears the market has been even worse.
Why is growth likely to continue? To start, households are the key to any economic forecast, since they represent nearly 70% of the economy. Average wages are rising at a 4% annual rate (although this is a touch depressed when so many new hires are lower paid immigrants) and employment is growing by nearly 1%, using the slower pace of the last three month, which implies 5% nominal household income growth. (We strongly suspect the government’s benchmark revision of job growth downward was excessive and actual job growth is higher than estimated.) Inflation of 2.8%, even without any further moderation, implies that real household income is currently expanding at a 2.2% annual rate. So, 2% growth in consumption is easily sustainable. Capital investment is even stronger, as firms bring manufacturing onshore, expand on green initiatives and technology firms make enormous investments in AI. In fact, corporations have been very active issuing bonds to raise capital, even as earnings estimates keep rising. So, firms have lots of dry powder to pay for investments. And banks have excess capital. Housing has been up and down this year, but should gather strength as rates decline, since we still have a housing shortage. With two wars going on and a need to replenish munition stockpiles, defense spending should also continue rising. There are some pockets of weakness, such as commercial office buildings. But those are few and far between. The biggest headwind to growth is uncertainty, with those two wars going on and an impending election. Historically, capital has flowed into bonds instead of stocks during such periods to reflect that higher source of uncertainty. But then there’s the Fed, which is about to lower rates. We still see no recession in 2024, and the economy may pick up steam in 2025. Market fears appear misplaced.
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