MAGGIE LAKE: How can the US be in recession when the labor market is expanding so rapidly? Hey, everyone, welcome to the Daily Briefing. Jeff Schulze from ClearBridge is here with us today to help break down the US payroll report and what it means for the Fed and interest rates.
Hi, Jeff. So, yeah, jobs Friday, and boy, this was a bit of a shocker. The US economy added 528,000 jobs in July, unemployment down to 3.5%. What do you think this number is telling us?
JEFFREY SCHULZE: Well, I think this number is telling us what we've seen throughout the course of the first half of this year that the US economy is clearly not in a recession quite yet. If you look at job gains, it was broad based. So the unemployment rate comes down. And I think this puts some pressure on the Fed to keep their foot on the brakes and continue to be very hawkish from a monetary standpoint.
And this was clearly reflected in another rate hike priced into the markets over the course of this first year of this tightening cycle. So all in all, the economy is still moving forward, although it's decelerating. We still have a really strong labor market. And it's going to take some more pressure from the Fed to bring that under pressure.
MAGGIE LAKE: So you just said something really interesting and this is I think what we need to dig into. You said it, we did have a strong labor market, I think, but now it's decelerating. So you see this number and you think like, we're not only not recession-like, it's pretty smoking here. This looks like a really good growth number. But what do we need to understand about the timing? Why are you saying it's decelerating when we have unemployment at 3.5%?
JEFFREY SCHULZE: Well, the economy overall is decelerating. In fact, the labor market is continuing to be healthy, just to put a number around how strong today's print was. If you go back to the last decade, from 2010 through the end of 2019, the average job creation per month was 183,000. Today's print was three times that number, right? So you continue to have a strong labor market, but you're seeing signs of deceleration across the economy, you're seeing it in housing.
The NAHB home builders survey had its second largest monthly drop. Earlier, a couple of weeks ago, we've seen weaker housing starts, weaker permits, you're seeing it in manufacturing PMI, which tends to lead the economy by two quarters, that came in at 52.8. But the more forward-looking component of that, new orders dropped to 48 which is almost recessionary. So you're seeing some deterioration in the US economy, but you're seeing some pockets of strength and the last area of resilience is clearly the labor market here.
MAGGIE LAKE: Yeah. So actually, some of the stuff that you were talking about, I think you charted on a recession dashboard, which I think is really helpful. Because you can't just look at this one number, you can't just look at jobs. And I've been hearing a lot of the people that come on air have really been pointing out that there are leading and lagging indicators. And so, something like an employment report, I think grabs headlines, especially when it's this strong.
When you look across your dashboard, which I think we're going to be able to pull up, do we need to think about in terms of what is leading and what is telling us what's going to happen in the future, which is what we want to do with our investment choices, right? And what's happening in the past, does that matter? And where does jobs fall in that lineup?
JEFFREY SCHULZE: Well, jobs are really more of a coincident indicator. It usually sees strong job creation, and then all of a sudden, when you head into a recession, it drops pretty meaningfully. But at 500,000 plus jobs being created, again, I think we're going to see much more of a deceleration if we ended up going into recession. But you can see from our dashboard, we've had a lot of deterioration in the dashboard over the last two months in particular.
In July, we had three indicator changes. And this is a stoplight analogy where green is expansion, yellow is caution, and red is recession. And the three indicator changes that we had last month were commodities and retail sales both going to red, the yield curve moving to yellow, but I think more importantly, we've gone to an overall yellow cautionary signal. And recession risks are rising pretty dramatically as the Fed tightening starts to make its way into the economy.
And talking about the labor market really quickly, Maggie, although the headline jobs print is really important for the path of Fed policy, my favorite labor market indicator is initial jobless claims. It's one of the top three variables in the dashboard. Usually, it's the last one to turn red. And claims have been rising. They're up to 260,000 per week. If they continue to rise to the high 200,000 per week or maybe low 300,000 per week range, I'm going to be a lot more concerned that recession is going to be more of a base case than it already is.
MAGGIE LAKE: That's so interesting. And I think that one of the things we were talking about when we were with the editorial team, when we were discussing the number and getting ready for the show was, wait a minute, haven't we been seeing headlines about layoffs? Almost every day, we've been seeing, and maybe they're not massive, but they're pretty consistent. And we've certainly heard some of it through earnings as well, companies talking about that.
That would be showing up in the weekly jobless claims. Why isn't that captured more in this monthly number? Can we, I don't want to say trust the number, but we know these numbers get revised, we know that both on a monthly basis, and when the next month comes out, and also, at the end of the year, right?
We talked about this in a recent interview on Real Vision, there's a big like, goes back a year and looks at everything and revises it. Should we not be putting that much faith in this jobs report, or is the labor market strong, it's just potentially going to change or be one of the last things that change?
JEFFREY SCHULZE: Well, you make a lot of interesting points there. And if you paint a broader mosaic of the labor market, yes, this was a blockbuster print. But you get the establishment number, which we saw at 528,000 today. We also have the household number. So there's two labor surveys that are out there, and although the household number was positive at 177,000 this month, over the prior three months, it wasn't positive. It was showing a very different picture than the headline jobs number, with initial jobless claims continuing to creep higher from here.
And let's not forget job openings are down 1.2 million over the last three months, right? So you're seeing peak labor tightness, a lot of these pieces of the puzzle are pointing to a slower labor market rather than the strong print that we saw today. So I think it's going to take some time to get a better handle on which direction it's going. But I put my money on the fact that the labor market's probably slowing rather than staying as strong as this headline number suggests.
MAGGIE LAKE: Are you surprised we're not seeing it yet?
JEFFREY SCHULZE: I am, I am surprised. Makes sense why you have so many job openings and this thirst for labor. Last year was the strongest year of real economic activity in the US since 1984. You had pandemic related issues with people not wanting to come back into the labor market, and people who were flushed with cash from the pandemic unemployment benefits. But again, all of that is moving in reverse now.
You have a fiscal negative impulse on the US economy, a lot of those cash cushions have been spent and economic growth is clearly decelerating at this point. And the Fed really wants to tamp that down. So my view is that this was a surprise number. To me personally, I think that we're going to see a materially slower labor market as we move to the back half of the year.
MAGGIE LAKE: Negative fiscal impulse, basically, no benefits, no benefits stimulus packages coming from the government. And we know probably, although a little one just passed, we're probably going to grind into gridlock as we head into the midterms. Alright, so that's a really great discussion on the growth picture. We know the other thing that really matters is inflation, especially when it comes to the Fed.
And so, I always thought that or used to have economists tell me that the labor market's really important. Wages are really important because they're sticky, right? Food prices go up and down at the grocery store. But once people get a raise, they don't give it back. And it gets built into structural inflation. How much does the wage component matter here? And does the strength of labor market, the fact that it's hanging on so long, is that a problem for the Fed?
JEFFREY SCHULZE: It is a problem from the Fed. And there is again, a mosaic that you painted on wages, not all signals are pointing in the same direction up until the print that we got today. There's three major measures of wages, you have the average hourly earnings that come out in today's report, that jumped up to a half a percent month over month. So that's a reacceleration from what you've seen here recently. You have the Atlanta Fed wage tracker, which has continued to accelerate all yours at 6.7%.
You have the employment cost index, the ECI, which we just got a week ago, which showed acceleration. So two were showing acceleration, average hourly earnings up until this release were showing a deceleration. Now, with this reversal, I think the Fed has to remain hawkish because wage growth is not coming down to the level that would be consistent with a 2% or 3% inflation number.
So unfortunately, now that they're all singing from the same hymn book, I think this creates a path for a hawkish Fed going forward. And I think the markets are a little bit too optimistic for that dovish pivot.
MAGGIE LAKE: Yeah, so we've got some great questions coming in. And Joe, Roger, welcome to the conversation. Everyone else out there, feel free to drop them in and we'll get as many in as we can. Joe C asking, if the dashboard has turned from green to yellow, can it go back to green? Or is this a sign that read is next? Essentially, can this be a soft landing? Great question, Joe.
JEFFREY SCHULZE: Yeah, so if you look at the dashboard history, which goes all the way back to the early 1960s, you've had 12 yellow signals overall Eight of those turned into recessions. Four of those were nonrecessionary. Now, in three of those instances, the dashboard turned yellow and went back to green. And only one of those instances, it went to a red signal, and a recession never materialized.
But I think, importantly, with those three times where it went yellow back to green, in each of those instances, 1995, 1998 and 2016, the Fed had a dovish pivot. In 1995 and 1998, they ended up cutting rates by 75 basis points in each of those instances. And in 2016, the markets were pricing in four rate hikes for that year that Janet Yellen took three of those rate hikes off the table in the early part of 2016. So the net effect was a 75-basis point loosening.
Now, you fast forward to today, again, with his hot jobs number that we have here, potentially another inflation point that we're going to get next week. And then we're going to get an August and September before the next FOMC meeting. I don't see the Fed moving away from this current hawkish path of tightening with inflation with a 9-handle on it currently. So, again, there has been instances where it went back to green, but the Fed was instrumental on those reversals.
MAGGIE LAKE: So Roger, with another great question, if you knew the jobs report would be this big, wouldn't you have thought the markets would be down? A lot of people, very confused by the market reaction we're seeing and for those of you who maybe are out on a Friday afternoon or late Friday evening, if you're in Europe or not in front of any computer, we did see bond yields move this day, we saw a spike in yields on the 10Y, 2.8 and change right now, but stocks and that's what the question is referring to, remarkably calm.
We saw the Dow up 0.25%, NASDAQ was down 0.50%, S&P fractionally, small caps were up. And you see the VIX at 21. Are you surprised by that?
JEFFREY SCHULZE: I personally am surprised when you first got the release this morning, markets were down about 1%. And they've rallied back. And this is again, as you mentioned, with the rise of the 10Y Treasury of around 15 basis points. I think the markets are sniffing out a weaker inflation print. I think that's what the markets are signaling here. There's a nowcasting tool put out by the Cleveland Fed, and they estimate what inflation is going to be before it actually comes out.
And the July print for CPI is expected to be 0.27% on a month-over-month basis. If you annualize that, that's 3.24%. And that's obviously because you've had lower energy and lower food prices over the course of this month. So if we get a CPI print, even though the year-over-year number is going to be high, it takes a long time for these changes to filter into those numbers. On a month-over-month basis, which is what the Fed is going to be looking at, we get something in line with what is being projected by the nowcasting tool.
You call it 0.3%, 0.4%, I think the markets are going to continue to rally and have hope that maybe the Fed won't be as hawkish as what's initially feared. But that's my read into it. It certainly was surprising to me.
MAGGIE LAKE: Yeah, it's really interesting, because Harry Melandri sat down with Teddy Vallee, the founder and CIO of Pervalle Global recently, and they talked about something that I think is really relevant to this. And it was basically how rapidly everything's been moving. Let's have a listen to that clip.
TEDDY VALLEE: We came into this year, and we were very, very negative on the bond market. We were both thinking growth and inflation were going to continue higher probably through the end of Q1, maybe into a little bit of Q2. And the Fed was just completely outside and caused them to play this type of catchup, which would not be good for a lot of risk assets. And that's pretty much played out.
If we look at some of the leading indicators looking forward, all of them are straight lower. The thing that I'm contemplating working with right now is that these are evolving at such a rapid pace that I would have expected some of the economic numbers that we've done recently, whether that be regional Fed surveys or some of the new orders to inventory ISM prints, I would expect these things to play out over a longer period of time, but everything's happening at such a rapid rate that the slowdown today is really taking hold.
And that's partially due to what the Fed has done. These are some of the largest six-month moves in 2Y rates, mortgage rates, and etc., etc. that's leading to, I just saw today the two-month rate of change of median home prices is down 11.9%, which has never happened before. And you're seeing now huge, big moves on the prices paid front. Yesterday, ISM came out with prices paid and it was the biggest move to the downside in a decade, the fourth largest move since 1948.
So, things are just moving at such a rapid pace. So, if I'm thinking about the world looking forward, I'm seeing growth that is still going down and accelerating pretty, pretty swiftly and inflation is likely to follow suit as well. I think that's the biggest variant view or variant perception I have on the inflation front and I could ultimately be wrong, but my base case is that inflation is going to fade much faster call it by the end of Q1 than the market thinks.
So, right now, for me, if I look across historical growth cycles, all of those ratios are tracking the average drawdown of a growth down cycle except for bonds. On average, bonds are up, call it the long end, so 30Y Treasurys are up on average 24%. And now, we're down about 15. So, there's huge discrepancy between how bonds are trading relative to a normal growth down cycle and where we're at today. And that's become our largest focus. And it seems it's related to both the Fed and inflation.
So, if I'm looking out over the next six, nine months, I think inflation is really going to undershoot to the downside, which is where you're going to have some significant amount of opportunity.
MAGGIE LAKE: And that full interview is available on our website. And it's worth pointing out that Teddy's fund posted a 21% return in the first quarter because he got that inflation call right. And, Jeff, that inflation call is so critical now. And definitely, there's a wide, I'd say field of opinion and not a lot of consensus on this. Teddy's in the camp that is going to fall quickly. It sounds like you agree with him somewhat that you do think that we could get this turn in inflation?
JEFFREY SCHULZE: I do. I do. I think there's clear signs of deceleration, you're seeing it across the commodity complex, the energy complex, which is going to start to filter into those numbers on a month-over-month basis, you're seeing a lot of inventory glut at the retailers, again, huge misses for Walmart and Target. Yet again, that discounting is going to make its way into inflation.
There is going to be some sticky areas. Obviously, shelter is going to be sticky, housing prices lead inflation by about 14 months, and with home price appreciation still at very strong levels, that's not something that's going to come out of the overall inflation numbers until we get to the middle part of next year. But I do think inflation is going to move down in a more meaningful fashion.
But I think from the Fed's vantage point, what's that line of demarcation where they feel that that trend is well established, and they can start to focus on saving the economy? Back in 1982, Paul Volcker and the Fed started to get very dovish that year when CPI was running at 6% or 7%. And even though they got dovish, you fast forward to 1983, CPI fell to 2%.
So obviously, we were in very deep recession, very different dynamic than what we have today. But I think the key here is inflation is a lagging indicator. And what's that line of demarcation for the Fed? Is it 4%? Is it 5%? Certainly not going to be 2% or 3%, but what's that point of a pivot?