Weekly Signal & Noise Filter

The Risk Has Gone From a Soft Landing to a Hard Slowdown

While the above is not a foregone conclusion, the Fed is now in playing with fire territory. 

The current signals from the labor market point towards a hard slowdown (not recession) for the economy if this Fed does not front run further deterioration, either in fact (aggressive cuts) or through forward guidance.

The August employment report has changed the information surface.  No need to spill more digital ink on the prints everyone knows.  The task at hand now is to contextualize this information surface, develop a new projected information surface, and front run the Fed’s reaction function to it so we can make some cash.

We start with the U3 rate itself.  On the face of it, the decline from 4.3% to 4.2% seems like a cause for celebration.  It is not.

The three-month moving average for the U3 rate moved up from 4.13% to 4.2%.  This represents a continued acceleration (though less so) in the deterioration of the labor market.

The decline in convexity is likely an echo from July, when markets begin to price in the Fed cutting cycle commencing in September. 

This decline however, while welcome, is not enough.  The Sahm indicator has moved deeper into recession zone, moving from .533 to .567.

In addition, the 3-month moving average for non-farm payrolls (NFP) declined from 141k to 116k.  Here, convexity appears to be ticking up (steeper downward line).

• The convex nature of labor market deterioration makes it clear this momentum will require a more forceful policy response from the Fed if it to succeed in meeting its year-end U3 target of 4.0% (from the June SEP).

• The Fed is behind the curve, and it appears bureaucratic inertia is outweighing institutional decisiveness to front run additional weakness.

The question now is if this level of deterioration a feature or a bug for the forward trajectory of the economy, and assess the relative risks of the soft landing morphing into a hard slowdown.

Instead of cherry picking the data to support the narrative, Pinebrook prefers to lean on market signals at the shorter end of the curve, which closer reflect market participant expectations and gauge where Fed policy is relative to those expectations.