Markets Fall in the Fall
August was a volatile month. Late summer has generally been a challenging period for equity markets. But why this year? Well, by the end of July, the markets were riding the resilient economy and declining inflation themes. Expectations among many investors were for those themes to continue unabated. But those expectations were not supported by the data released in August. Signs of economic slowing were there for investors to see.
Then, as the data came into focus in late August, expectations of a Fed pause pushed yields down and stock prices up again. Where does that leave us? In our view, with the soft-landing scenario still intact. But especially with the labor market (finally) showing signs of loosening, things are getting trickier for the Fed.
The August labor report was our best indication, so far, that the aggressive interest rate hikes by the Fed are taking hold. While non-farm payrolls grew by 187,000, significant negative adjustments were made for the June and July reports. We also saw the unemployment rate go up to 3.8%, the highest level since February 2022. Average hourly earnings (a big factor for inflation) were also below what was anticipated.
What this all means is that we’re seeing a decline in demand for new workers while demand for existing workers holds up. Unless we see significant increases in layoffs (we haven’t yet) and the unemployment rate, the labor story falls into the soft-landing camp.
A soft landing, while our base case, is not a done deal. Rarely in the last 50 years has a rate hike regime not resulted in a recession. By some estimates it takes 18 months or more for interest rates to have an impact and the effects can be variable. We’re starting to see the effects in areas such as labor now.
The resilience of the US consumer is the #1 factor that points to a soft landing. Consumer spending continues to be strong, although we’re seeing signs of borrowing to do it
Still, there is the risk of recession, which could push equity prices to 2022 levels or below.With us, the big question is whether the Fed will overdo it? In the past, often they have.But this is different time and a different Fed.While they are talking tough, our view is that the Fed will sit back and let their aggressive hiking to date play out.In other words, they will not overshoot on rates and ease the economy through this tough period without a recession.So far, the evidence has backed our analysis.It’s just not going to be a smooth ride for the markets if confidence in the Fed’s chances for success wavers.