Q4 2024 Cash Outlook Key Job Market Metrics Predict Recession

The probability of a recession currently sits at around 50 percent thus, remaining long duration and cautious on credit seems to be the prudent strategy for the time being. The path ahead is uncertain, but careful attention to the evolving job market will be key to navigating these challenges.

September’s economic narrative was dominated by one central theme: jobs. In his Jackson Hole speech back in August and again during the September Federal Open Market Committee (FOMC) press conference, Chairman Jerome Powell made it clear that the US Federal Reserve’s (Fed’s) focus has shifted toward the labor market now that inflation seems to be more under control.

The Fed is satisfied with inflation expectations aligning with its mandate, which is critical because inflation expectations drive consumer behavior. While inflation itself had been trending downward, the Fed recognized that managing perceptions is equally as important as managing reality. It was crucial to ensure that people understood inflation was under control, even as the actual figures started to reflect improvement.

A Shift Toward Jobs

Now that inflation appears to be stabilizing, the Fed’s attention has turned toward preventing a hard landing for the economy. A soft landing, where inflation is contained without triggering a severe recession, is the goal—but historically, the Fed has only achieved this twice in the last 11 recessions. It is a tall order, and Chairman Powell’s tone reflects the challenges ahead.

Key Job Market Metrics Signal Trouble

The Sahm Rule, named after the US economist Claudia Sahm, predicts recessions when the three-month moving average of the national unemployment rate (U3) rises by 0.50% or more from its lowest point in the previous 12 months.

We have recently crossed this threshold, indicating that a recession could be on the horizon, though it should be noted that many economists, including Claudia Sahm, are questioning the reliability of this indicator amid today’s unique economic conditions.

Another important tool for understanding the dynamics in the labor market is the Beveridge Curve, named after the British Economist William Beveridge. It shows the relationship between job vacancies and unemployment, and is helpful in determining the imbalances in the labor force. A curve further to the right indicates an imbalance in labor force skills. A curve to the left indicates skills match more closely to the jobs available. The Beveridge Curve helps policymakers and economists understand not only where the economy is in the business cycle but also the efficiency of the labor market and whether problems are cyclical or structural.

Demographics and the Labor Market

One significant factor that could shape the labor market in the months and years ahead is demographics. Are we facing a shortage of workers? This is a challenging question to answer without knowing the full potential of our economy. Since January 2023, the total number of workers in the US economy has remained stagnant at around 161 million—approximately 63% of the eligible workforce as reflected by the labor force participation rate, a rate that has still not recovered from the highs of 67% two decades ago.

If we had stayed on the same growth path that we were on before COVID-19, we would have had about 3 million more workers in the economy today. This labor shortfall poses a risk to future economic expansion. For the economy to grow and thrive, the number of workers will need to increase. Over the coming years, it will be crucial to see how we can expand this group to meet the demands of a growing economy. In this context, it is no surprise that Chairman Powell stated, “We do not seek or welcome further cooling in the labor market conditions.”

Fed’s Next Moves

September’s 50 bp policy ease raises an important question: Will we see more significant cuts in the future? As it stands, we are forecasting two more policy eases of 25 bp each at the November and December FOMC meetings, followed by five more next year. However, there is a risk that the Fed may need to act more aggressively depending on how the data unfolds. Even at the time of this writing, Powell continues to reiterate that the Fed will lower rates “over time” depending on the data.

The job market data, starting with the September non-farm payrolls, will be especially important. Historically, non-farm payrolls have averaged about +126,000 per month over the last 70 years, but the disruptions from COVID-19 have added significant volatility to this data.

The September non-farm payroll number came in much higher than expected at 254,000 and now points to a more gradual path of policy cuts in the coming months.

Prudent Positioning

Given that the probability of a recession currently sits around 50%, we believe the Fed’s chances of achieving a soft landing to be small. We believe that remaining long duration and cautious on credit (as we have been for some time now) is the prudent strategy for the time being. The path ahead is uncertain, but careful attention to the evolving job market will be key to navigating these challenges.

In conclusion, the coming months will tell us whether the Fed can successfully manage the delicate balance between fostering a stable labor market and avoiding a hard economic landing.