The Jobs Mosaic

Economic

Summary:

It is quite clear that job growth has slowed over the past year as the post-covid rebound has faded. But is the labor market stalling, or just slowing to a more gradual pace?

The two main government surveys on the U.S. job market are both facing significant challenges in shedding light on this question. Since November 2021, one survey shows employment has grown by 9.6 million jobs, while the other shows a rise of just 5.9 million workers. This 3.7 million gap reflects the mixed signals the government’s monthly reports have been showing for quite some time now.

Fortunately, we have other angles from which we can assess the state of the job market. Apart from the monthly jobs report, we also get weekly updates on how many people are claiming unemployment benefits and various private sector surveys. In addition, we can look at the economic forces that typically drive employment growth to consider what should be happening to the job market, along with data that typically reflect the economic consequences of job growth.

Together, all of these perspectives constitute a mosaic that produces a much clearer picture of the labor market. So far, this picture is of an economy and labor market that is slowing rather than stalling. However, this slower-moving expansion is also more vulnerable, underscoring the need for policy makers to be particularly careful in their actions and messaging when embarking on a rate cutting cycle, and a need for investors to be extra vigilant in watching all of these labor market signals in case they more broadly turn south.

The Challenge in Measuring Jobs

Both the establishment and household surveys face significant challenges in providing an accurate portrayal of the labor market. For starters, they are both surveys rather than population counts (of roughly 119,000 companies and 60,000 households respectively), which makes them subject to sampling error. This issue, on its own, is quite significant. Indeed, because of sample size, the Bureau of Labor Statistics (BLS) estimates that it can only be 90% confident that the true number is correct within 130,000 either way of the payrolls figure and within 0.2% either way of the unemployment rate. To put this in perspective, on Friday, the BLS reported a monthly job gain of 142,000 and an unemployment rate of 4.2%. However, the BLS is only 90% confident that the true payroll gain was between 12,000 and 272,000 or that the unemployment rate was between 4.0% and 4.4%.

In addition, survey response rates for these two surveys have fallen sharply in recent years. For the household survey, the response rate has dropped from 89% to 70% over the past decade. For the establishment survey, over virtually the same period, it has fallen from 63% to just 43%. Just as in political polls, any different patterns among non-respondents compared to respondents will further erode the accuracy of the figures.

A second issue has to do with seasonal adjustment. The markets and the public rightly focus on seasonally-adjusted employment data, but these seasonal adjustments are very significant. Without them, for example, over the past 10 years, the average January would have been reported with 2.8 million fewer jobs and the average November with 600,000 more. Seasonal factors are calculated based on the seasonal patterns of previous years. However, the extraordinary swings in the data over the course of the pandemic distorted all of these patterns. In addition, the pandemic itself, by creating industry winners and losers and by changing behavior with regard to work from home likely further distorted these patterns, casting more doubt on the accuracy of these numbers.

Third, there is the issue of immigration. The household survey is bolted on to estimates of the growth in the civilian population aged 16 and older provided by the Census Bureau. However, these numbers show an increase of just 1.6 million in this population over the past year. While data on immigration and its effect on the labor force are subject to uncertainty, estimates from the CBO and Brookings suggest immigration could account for 2-3 million additional workers since 2022. A underestimation of the civilian population would help explain why the reported 0.4% increase in the unemployment rate and 0.1% decline in the labor force participation rate over the past year resulted in employment falling by 66,000 workers over the same period, which is entirely at variance with other employment measures.

It should be emphasized that none of this implies that the BLS is somehow faking the numbers or, worse still, doing so for political purposes. We firmly believe that the BLS is doing its best to honestly portray the state of the job market. However, it does underscore the need for constructing a broader mosaic of the jobs picture and assessing the signals from different vantage points.

The Government Surveys of Companies: Flashing Orange

On its surface, the August reported payroll gain of 142,000 seemed relatively benign – only slightly below the 165,000 consensus expectation and close to the 163,000 average monthly gain seen over the last decade. However, revisions further chipped away at gains for the prior two months which are now estimated at 118,000 and 89,000 respectively, bringing the three-month moving average down to a lackluster 116,000. On a more positive note, the average workweek increased by 0.1 hours and average hourly earnings climbed by 0.4%, or 3.8% year-over-year, very likely marking a 16th consecutive month of year-over-year wage gains outpacing consumer price inflation.

It is worth noting that the recent preliminary annual benchmark revision to the payroll survey subtracted 818,000 from the employment figures for the twelve months preceding March 2024. This would cut the gain in employment in that time frame from 2.900 million jobs to 2.082 million jobs and could indicate a lower trajectory on job growth since then. However, the latest revisions reflect new population estimates from unemployment insurance tax records, which likely undercount new migrants. The revised data are also subject to another revision in February 2025, and large revisions are not uncommon in this process.

A second government survey of businesses, the JOLTs report, provided further confirmation of labor market cooling with the number of job openings falling from 7.910 million at the end of June to 7.673 million at the end of July. However, while well off their peak of 12.2 million, current job openings are still higher than in any month prior to the pandemic.

The Government Household Surveys: Flashing Orange

The household survey saw modest improvement in August relative to July with the unemployment rate falling from 4.25% to 4.22% and the economy adding 168,000 workers. However, the unemployment rate has still risen significantly since hitting a 54-year low of 3.43% in April 2023, with a rising, although still very low, number of workers reporting that they worked only part-time for economic reasons.

It is important to note that while unemployment has been rising, layoffs remain at historically low levels, suggesting that this deterioration may simply be a correction from the super-hot labor market of 2022 and 2023, when many people who would normally have trouble keeping a job found themselves in employment. If so, the economy could settle in to an unemployment rate just over 4%. However, the direction of travel over the past year is still cause for some concern.

Private Surveys: Flashing Orange

In addition to the government surveys, we can look to monthly readings from a number of private sector reports. In particular,

The employment components of the ISM surveys of purchasing managers were mixed in August, with the manufacturing report showing job losses and the (much larger) service sector showing gains.The August Conference Board Survey of Consumers was generally positive, with 32.8% of respondents saying jobs were “plentiful”, exactly twice as many as the 16.4% reporting that they were “hard to get”.The monthly jobs report from the National Federation of Independent Business was also generally positive, with a net 13% of firms planning to increase rather than cut employment over the next three months and a still very elevated 40% reporting job openings they could not fill.On the more downbeat side, layoff announcements jumped to 76,000 in August from a historically low 26,000 in July according to the outplacement firm, Challenger, Gray and Christmas.

Unemployment Claims: Green Again

Weekly unemployment claims provide a further timely perspective on the labor market.

Over the summer, they did seem to suggest some reason for concern, with a four-week moving average of initial claims climbing from 210,000 at the end of April to over 240,000 by the start of August. However, some of this appears to have been due to weather effects and seasonal plant closings in the auto industry. By the end of August, the four-week moving average had fallen back to 231,000, with a similar improvement in continuing claims. Overall, initial claims for unemployment benefits are lower than they have been more than 80% of the time this century, suggesting a generally tight and healthy labor market.

The Drivers and Impacts of Job Growth: Still Looking Good

A final and important perspective on the job market comes from looking at the rest of the economy. In our medium-term forecasting models, private sector non-farm employment is positively related to current real GDP growth as well as growth in the prior two quarters. When businesses experience rising demand, they attempt to hire more workers and are more reluctant to layoff existing employees. Following slow growth of 1.4% annualized in the first quarter, real GDP growth accelerated to 3.0% in the second. The Atlanta Fed’s GDPNow model is predicting 2.1% growth for the third quarter, largely in line with our own forecasts, which suggests that there should be plenty of business momentum motivating hiring in the months ahead. This perspective is further bolstered by strong year-over-year gains in second-quarter profits according to both government and private sector reports.

Finally, we can look at the consequences of employment growth, particularly in the form of consumer spending. Following annualized gains of 1.5% and 2.9% in the first and second quarters respectively, we are now tracking a 3.2% gain in real consumer spending for the third quarter. To be sure, many families are still struggling and the public mood remains sour. However, the roads, airports, restaurants and grocery stores are generally full and online spending continues to grow. There is no sign of an employment slump in the spending of American households.

Conclusion

Putting it all together, the Jobs Mosaic suggests an economy that is, for now, settling into a slower expansion rather than anything more sinister. It should be emphasized that slow expansion is a fairly natural condition for the economy. Every morning, millions of Americans wake up willing to work more hours, wanting to buy more stuff and generally striving to get ahead.

That being said, a slower-growing economy is also a more vulnerable one and the Federal Reserve needs to be careful in both their actions and their words. The right move from here would likely be to cut the federal funds rate by 25 basis points on September 18th and justify this move by saying that a healthy economic expansion, with inflation falling towards the Fed’s 2% goal, doesn’t need monetary restraint and that it will be gradually removed over the next year or two. The wrong thing to do would be to cut by 50 basis points and express recession concerns.

For investors, it will be important to watch both the evolving jobs mosaic and how the Fed reacts to it. However, it is more important that they consider whether the sharp market moves of the last two years or any changes in their own personal circumstances justify a rebalancing of portfolios. While we are not particularly concerned about the balance of current economic data, the economy and markets are always vulnerable to shocks, and long-term financial success depends as much on being able to weather what you don’t expect as to profit from what you do.

To stay updated on all economic events of today, please check out our Economic calendar

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Warren Takunda

Economic

The Pound to Dollar exchange rate (GBP/USD) rose three-quarters of a per cent on Monday and is holding the gains on Tuesday, quoting at 1.3210, placing it 50 pips shy of the 2025 high.

Gains in GBP/USD are driven by USD weakness as markets raise expectations for a 50 basis point rate cut at the Federal Reserve on Wednesday. However, a decision to leave UK interest rates unchanged at the Bank of England on Thursday is also said to be helping.

"For now, the ramped up Fed cut expectations is having a deleterious effect on the USD broadly, and GBP/USD specifically as the BoE is expected to hold rates steady when it delivers its rate decision the day after the FOMC," says Paul Spirgel, a Reuters market analyst.

Can the Pound rally to the 2024 peak against the U.S. Dollar at 1.3270, potentially taking in even higher levels? A new research note says the GBP/USD risks stalling, meaning those looking for the best dollar rate should consider locking in part of their exposure around today's current levels.

Markets now see a 75% chance of a 50bp interest rate cut at the Fed on Wednesday, whereas this time, one week ago, the odds were at only ~30%. The ramp-up in odds for a 50bp cut followed a pair of media reports last Thursday that said a 50bp was in play, with analysts noting the close links between the author of one article in the WSJ and the Fed.

Because the report is unsubstantiated, there is a real risk of disappointment. Should a 25bp rate cut be delivered, then the Dollar can recover and GBP/USD will drop sharply. "Sterling is vulnerable should the Fed only cut 25bp," says Clyde Wardle, Senior EM FX Strategist at HSBC.

Wardle says a 25bp cut scenario would see the USD shift onto better ground, "especially given the extensive pricing for rate cuts already factored into markets and signs of excessive short USD positioning."

Money markets show there are nearly 260bp worth of cuts priced by the market by the end of 2025, while the latest IMM report shows the total net short USD position stood at its largest since August 2023.

This means the market is already betting heavily against the Dollar and Wardle says, "the Fed would have to meaningfully 'out-dove' easing expectations in terms of its dots and messaging than what the market is already pricing."

"That said, kicking off with a deeper, 50bp cut this week may – at least in the short term – could see the USD weaken," he adds.

The Bank of England decides a day later, and markets see minimal chances of a cut with a clear majority of the Monetary Policy Committee voting to keep rates unchanged.

But, currency market analysts say the Pound can come under pressure if the vote is tighter than expected.

Ahead of the Bank's decision is the release of UK CPI data on Wednesday, which Wardle thinks could alter the Bank's thinking.

"The risk is that these data soften more than expected, as other forward-looking indicators show UK price pressures abating. It is less clear what can boost GBP’s strong run further, especially when some positioning metrics suggest it is a very crowded long (i.e. record net long GBPs on IMM)," says Wardle.

With positioning in the Pound and Dollar stretched in opposite directions and the market close to fully pricing in a 50bp Fed cut and no action at the Bank of England, the impetus needed to clear the 1.2275 hurdle in GBP/USD is immense.

Source: Poundsterlinglive

To stay updated on all economic events of today, please check out our Economic calendar

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Alex

Cryptocurrency

As bitcoin mining undergoes major changes, the GCC region can have an important role in the transformation, which is being driven by a focus on renewable energy and new technology.

Abdumalik Mirakhmedov, executive president of GDA, one of the world’s largest bitcoin mining companies in terms of hash rate, says strong government support, an abundance of capital, and a commitment to sustainability are positioning the region as a growing force in the sector.

“Governments across the region are demonstrating enthusiastic support for the growth of bitcoin mining, recognizing its potential to drive broader sector development,” said Mirakhmedov, speaking from GDA’s Dubai office. “They are ramping up their green energy initiatives in a move that could propel the region to the forefront of sustainable bitcoin mining, and potentially secure a significant portion of the network’s hash rate.”

The UAE’s estimated 400 megawatts of bitcoin mining represent around four per cent of the global bitcoin mining hashrate, according to data from the Hashrate Index. The Oman government’s investment of more than $800 million in crypto-mining operations has also been widely reported.

“A common misconception about bitcoin mining is its purported dependence on fossil fuels and consequent environmental impact, but this outdated view no longer reflects reality,” said Mirakhmedov. “Current data shows that renewable energy sources now power more than 55 per cent of all bitcoin mining operations globally. Hydroelectricity, wind, and even captured methane gas have become go-to power sources for mining operations. This shift isn’t temporary, but indicative of a long-term trend, as renewable energy costs continue to decline, making them the obvious choice for miners worldwide,” he added.

Meanwhile, the adoption of advanced cooling technologies, such as liquid and immersion systems, promises to revolutionise operations, boosting energy efficiency and reducing costs. “As these technologies become more widespread, they’ll further enhance the sustainability of mining practices,” says Mirakhmedov.”

“While bitcoin mining strives to reduce its carbon footprint further, there are other benefits resulting from the industry’s ingenuity.

“In Sweden, for instance, the excess heat from mining rigs is being used to warm greenhouses and de-ice vehicles, turning what was once waste into a valuable resource. This kind of innovation will help secure the industry’s future, and the GCC region can play a big part in that.”

One of the world’s most experienced industrial-scale bitcoin mining companies, GDA operates 20 data centres across North America, South America, Europe, and Central Asia.

Source: khaleejtimes

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Alex

Commodity

Energy

Jet fuel production in the U.S. increased from pre-pandemic levels to 1.9 million barrels per day at the beginning of August, an increase of 8% compared to 2023

Over the summer, crude oil refiners ramped up activity to keep up with increased demand while closely monitoring the hurricane season through November 30

As people across the United States hit the road and jumped on planes this summer, gasoline demand surged. In July, demand reached 9.4 million barrels per day, equivalent to 395 million gallons per day, its highest levels since 2019, according to data from the Energy Information Administration (EIA). Strong consumption of oil coupled with the tightening of inventories could keep gasoline prices elevated for the remainder of the year.

Jet fuel production in the U.S. also soared from pre-pandemic levels to 1.9 million barrels per day at the beginning of August, an increase of 8% compared to the year prior. The Transportation Security Administration (TSA) checkpoint passenger travel numbers from January through July 2024 showed an increase of 6.2% compared to the same period in 2023, signaling a swift recovery in the civil aviation sector.

Gasoline demand topped initial projections this year. The AAA projected 70.9 million individuals will have traveled 50 or more miles from home over the summer, an increase of 5% compared to 2023. Meanwhile, Labor Day domestic travel bookings were up 9% over 2023, according to AAA.

In efforts to meet the higher demand for air travel, industry trade organization Airlines for America projected that U.S. carriers would provide an additional 26,000 scheduled flights per day, up nearly 1,400 a day from the summer of 2023. In July, North American carriers saw a 4.9% year-on-year increase in demand over the same period in 2023, according to the International Air Transport Association (IATA).

Despite the hurricane season getting off to an early start, gasoline prices in the Gulf Coast remained steady after Beryl, a Category 1 storm, reached landfall in Texas on July 8.

Lower Gasoline Prices Held Over Summer

The price of gasoline is predominantly underpinned by crude oil, as it is the primary driver, accounting for approximately 60% of the cost. The remaining 40% of the price is determined by refinery operations and distribution costs, and state and federal taxes. Front-month RBOB Gasoline futures prices averaged $2.31 per gallon in August 2024, $0.51 cents per gallon lower than they were during the same period a year prior. Gasoline prices in 2024 are expected to remain relatively flat with slower but consistent economic growth, according to the EIA.

Why Jet Fuel Demand Soared This Summer_1

Although jet fuel is a smaller component of the refined product mix than gasoline or other distillate fuel products, it has a significant impact on the economy. All civil aviation activity contributes about 1.3% of GDP, $535 billion in economic activity and 2.6 million jobs, according to the Federal Aviation Administration (FAA). Fuel is one of the largest, most variable expenses for airlines and represents approximately 15-20% of costs that impact the price of a passenger ticket. According to the most recent data from the Bureau of Transportation Statistics, the average price of a domestic airfare was $388 in Q1 2024 compared to $382 in Q1 2023.

Why Jet Fuel Demand Soared This Summer_2

Over the summer, refiners ramped up activity to keep up with increased demand while closely monitoring the hurricane season from June 1 to November 30, which could affect supply and contribute to price volatility in the future.

U.S. crude oil refiners expect to operate at approximately 90% of their combined processing capacity in the third quarter of this year. The largest U.S. refiner, Marathon Petroleum (MPC), said in August, it ran its refineries at 97% of their combined 3 million barrel-per-day capacity during the second quarter, compared to 82% in the first quarter, after their largest planned maintenance quarter in history. Marathon is positioned to run refineries at 90%, and Valero (VLO) at 92% of combined capacity in the third quarter.

In line with seasonal norms, gasoline inventories rose in the winter of 2023 in anticipation of the summer peak driving demand. Inventories took a steeper dive during the peak driving season this summer, decreasing by 3.7 million barrels to 223.8 million barrels at the end of July, 3% below the five-year average.

As gasoline transitions into the fall period, it could also be a key factor in campaigns during the upcoming U.S. election cycle. Given the upcoming uncertainty, demand for risk management in both jet fuel and gasoline markets is likely to remain strong.

Source: SEEKINGALPHA

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Cohen

Energy

Italy’s power utility Enel has become the latest international energy investor to scrap plans for participating in the energy transition of Vietnam.

According to unnamed sources who spoke to Reuters, Enel has decided to exit Vietnam’s wind and solar markets, with one source attributing the move to a broader company reorganization.

Earlier this year, Norway’s Equinor scrapped plans to invest in offshore wind in Vietnam. Wind turbine major Orsted also revised its plans for Vietnam, pausing a large-scale offshore development amid regulatory challenges.

Enel two years ago announced plans to invest in the construction of up to 6 GW of wind and solar capacity in Vietnam. The company, through its arm Enel Green Power, is one of the biggest wind and solar operators in the world with 64 GW of capacity. At the time it highlighted Vietnam’s considerable potential in wind and solar generation.

Indeed, Vietnam enjoys strong winds and shallow waters but at the same time, it appears to have a complicated grid connection mechanism, which has meant that a lot of completed wind and solar projects are yet to start generating because they need to be connected to the grid first.

This is rather unfortunate because Vietnam is suffering from tight energy supplies that earlier this year swung into a shortage, causing rolling blackouts. At the same time, the country has considerable ambitions in transition energy, planning to double its installed generation capacity by 2030. That capacity currently stands at some 80 GW. About a fifth of the doubled capacity should be wind turbines, per plans.

Yet it is wind power that is one of the biggest problems in Vietnam. According to Reuters, the government has yet to draft regulations for the development of offshore wind power projects and it also has to finalize negotiations on the price that it would undertake to pay to wind power project operators.

Source: OILPRICE

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ING

Economic

Flat prices in August are a welcome surprise

Inflationary pressures in Hungary eased in August. The latest data was better than expected when compared to the market consensus. Year-on-year inflation fell from 4.1% to 3.4% in August. The further moderation in inflation was partly due to the stagnation of the average price level on a monthly basis (MoM) and the high base from last year. Therefore, the strong monthly increase in July seems to have been an exception, as the stagnation in the monthly inflation rate seen in previous months has returned.

In recent months, inflation has been contained mainly by favourable developments in items outside the core inflation basket, and in August the main items of core inflation also turned more favourable. How long this will last remains to be seen, but the inflation picture is certainly improving.

Main drivers of the change in headline CPI (%)

Source: HCSO, ING

The details

Food prices did not continue to rise in August (0.0% MoM) after a surge in July (0.6% MoM), meaning that the removal of price caps and the end of mandatory in-store discounts appear to have led to a one-off repricing rather than a sustained, trend-like price increase. As a result, food inflation slowed to 2.4% YoY.

Fuel prices fell sharply in August (-0.8% MoM), following a sharp rise in July, which was widely expected. The contribution to the turnaround in inflation is therefore also significant. On the other hand, the 0.1% monthly fall in household energy is clearly a surprise, contrary to the expected rise.

Prices of durable goods rose by 0.1% on a monthly basis, in line with the global easing of pressure on these items due to lack of demand. At the same time, the price of clothing and footwear fell by 1.3% MoM, the largest fall since January.

Services should also be included among the items improving the short-term inflation picture. On a monthly basis, the increase was only 0.4%. However, due to an exceptionally low base last August, the year-on-year figure rose to 9.5%. This means that services inflation accounts for 73% of headline inflation.

The composition of headline inflation (ppt)

Source: HCSO, ING

Good news as the underlying inflation picture stabilises

Contrary to expectations, the core inflation indicator did not rise but fell slightly compared with July. The 0.3% month-on-month increase is close to the inflation target on an annualised basis. With this moderated repricing of the core basket, year-on-year core inflation was 4.63%, an improvement of 0.04ppt on the previous month. So the slowdown was just enough to help reduce the indicator due to rounding to one decimal place.

The good news continues with the National Bank of Hungary's measure of sticky price inflation, which remained unchanged at 5.8% year-on-year in August. Moreover, an important short-term indicator, the three-month annualised core inflation measure (3M/3M saar), has declined. Therefore, we can conclude that several indicators signal that the underlying inflation picture is at least stabilising, although there is still work to be done from a monetary policy perspective.

Headline and underlying inflation measures (% YoY)

Source: HCSO, NBH, ING

We revise down the inflation path

Looking ahead, we expect next month's inflation to be broadly similar to today's, with perhaps some moderation. Thereafter, however, the year-on-year rate could rise more sharply due to the low base. From October it could temporarily exceed 4% again. Looking at current inflation trends, we see the rate of price increases creeping back up to 4.8% by December 2024. This implies a significant downward revision on our part (from the 5.0-5.5% forecast range).

Given today's services inflation and the August fiscal data, we believe that the Hungarian economy could perform even more weakly in the second half of this year than previously expected. This will limit the ability of companies to reprice meaningfully, even in an environment where they face significant cost increases.

In the short term, therefore, inflationary pressures from the domestic demand side are unlikely to be significant. At the same time, inflationary risks are rising next year: the expected pick-up in consumption, continued dynamic wage growth (especially after a possible further significant increase in the minimum wage in 2025) and the government's recent tax measures are likely to be passed on to consumers in the form of price increases next year. We expect average price increases of 3.8% in 2024 and 4.2% in 2025.

The door is open for a 25bp cut in September

From a Hungarian monetary policy perspective, the incoming inflation data opens the door for a 25bp rate cut in September. A 50bp cut by the Fed (our low-conviction base case) and a dovish tone from the ECB (alongside its 0.25ppt rate cut) would reinforce this call.

On the other hand, "only" a 25bp cut by the Fed and a hawkish message from the ECB that the September cut will certainly not be followed by another one in October would make the decision between a hold and a 25bp cut in Hungary a bit more nuanced.

Ultimately, the EUR/HUF exchange rate could be the deciding factor and here the latest negative news (renewed and escalating disharmony between the government and the National Bank of Hungary) increases the country’s risk premium, which is also a key factor in the careful, patient and now stability-oriented monetary policy.

To stay updated on all economic events of today, please check out our Economic calendar

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Alex

Economic

If steep interest rate hikes failed to slow the U.S. economy much in recent years, it is reasonable to ask whether their reversal will prove as toothless in a downturn.

One of the puzzles of the past two years has been how five percentage points of tightening by the Federal Reserve between March 2022 and July 2023 had so little effect on the overall economy.

Despite the borrowing squeeze, U.S. real GDP has clocked annualized growth rates in excess of 2% in seven of the eight quarters since the middle of 2022 - and is on course to add to that tally in the three months through the end of September.

And for all its seasonal wobbles, the stock market is close to record highs.

This suggests that the economy has become increasingly desensitized to changes in short-term borrowing costs. If that is the case, then policymakers should be anxious that any slowdown from here - or even a cyclical recession - might also be inured to monetary policy easing.

'blunt' Interest Rates Pose Questions About Fed Easing_1

Several theories about this resilience to high rates abound: the peculiarity of the COVID-19 pandemic years, including the ample household savings and government spending present before the tightening; the high level of fixed-rate debt in the U.S., most notably mortgages; and elevated aggregate corporate cash levels that more than offset the hit that small firms took from the increase in debt servicing costs.

The last of the three is perhaps the most remarkable. Net interest payments made by U.S. firms as a share of GDP were halved during the tightening cycle, according to a recent International Monetary Fund report. Other research shows U.S firms' net interest payments as a share of cash flow have also fallen since 2022 to their lowest level in almost 70 years.

'blunt' Interest Rates Pose Questions About Fed Easing_2

Net interest payments of US non-financial firms fall as Fed rates rise

SENSITIVITY LOW

So what of the implications?

Interest rates are clearly set to come back down, with the Fed widely expected to start its easing next week. But given the limited economic impact of rates on the way up, some analysts have argued the U.S. central bank might need to push rates extremely low to stimulate the economy if a recession does indeed unfold.

U.S. stocks closed higher on Wednesday thanks to a boost from technology stocks and despite inflation data that soured investor sentiment early in the session.

Others may argue that the impact of higher rates has just been delayed and that the lagged effect over the past two years is evident in the erosion of cash levels on some household and corporate balance sheets.

But corporate borrowers are having little trouble rolling over their debt, even if they have to refinance at higher rates. Last week saw 59 new debt sales totaling more than $81 billion, the fifth-biggest weekly volume ever for investment grade companies, according to IFR.

'blunt' Interest Rates Pose Questions About Fed Easing_3

Some investors think this complex picture should inject much more caution into the Fed's thinking than markets are currently pricing in.

Yves Bonzon, the chief investment officer at Julius Baer, reckons uncertainty regarding the transmission of monetary policy to the private sector is "very high," largely because, as he argues, interest rates rose primarily to rein in "an income-driven rather than a debt-driven economic expansion".

"If the real economy's sensitivity to interest rates is unusually low, it is not clear how asset prices will react should the Fed meet market expectations and cut aggressively."

Bonzon's main point is that Fed easing in the absence of recession may well stimulate already accelerating private-sector credit growth, spur the housing market and related sectors and even revive the rate-stricken leveraged buyout and private equity market.

"In that context, the Fed would be mindful to avoid an asset price boom-and-bust cycle," he said, adding that three quarter-percentage-point rate cuts to start would be more than enough while the U.S. central bank continues to assess things.

'blunt' Interest Rates Pose Questions About Fed Easing_4

Hit to corp loans from Fed tightening is already fading

For BlackRock credit strategists Amanda Lynam and Dominique Bly, it all hinges on what you think the Fed is actually doing here.

Is it easing to offset signs of looming recession or just recalibrating now that inflation rates have moderated?

If it's the former, then that could result in deep policy rate cuts, but could also see a near doubling of high-yield credit spreads amid fears of a downturn.

On the other hand, the BlackRock strategists figure that if the Fed is just "normalizing" here, its terminal rate will likely end up much higher, around 3.5%, and credit spreads stay where they are.

Whatever your take, it's clear that no one - including the Fed - can be completely sure how this story will unfold over the coming year. That means investors should expect more edgy months like the one we are in right now.

'blunt' Interest Rates Pose Questions About Fed Easing_5