4 Alpha Research Researcher: Kamiu

Opinions in a nutshell

• The market is overreacting, reflecting Wall Street's consistent tendency to respond more dramatically to failed rate cuts, with the Fed having its own clever strategies.

• The rise in the unemployment rate in July is influenced by temporary factors such as hurricanes.

• The significant deviation of the July unemployment rate and new job additions from expectations has structural reasons, but it may not be entirely bad for the U.S. economy: the return of immigrants and workers exiting the labor force to the market helps to long-term suppress inflation.

I. The market may be overreacting to the July non-farm data, and the Fed does not agree that there is a huge recession risk

Historically, Wall Street's desire for loose monetary policy in the face of recession risks has always been greater than its pursuit of hawkish policies when facing economic overheating and inflation risks, meaning that the U.S. market's "elasticity" for rate cuts is always higher than for rate hikes, and its risk preference for inflation is higher than for deflation.

The July FOMC decision did not preemptively cut rates as optimistically expected by some observers. The fact that the U.S. market, which had priced in this expectation, did not crash after the announcement may be the last act of kindness. The subsequent plunge in nearly all major asset prices, significantly below expectations, expressed the market's dissatisfaction with the Fed's "slow action," with Musk bluntly stating that "the Fed's decision not to cut rates in July is foolish."

In this emotional climate, the spiral decline caused by long positions being liquidated does not fully explain that the July non-farm employment data directly points to a hard landing and a cliff-like recession.

The Fed likely does not believe that the U.S. is facing a huge recession risk. It is generally believed that FOMC voting members can see some economic data for the month before voting on decisions, although this data is usually limited. According to the Fed's meeting minutes, officials emphasize the need to base future decisions on upcoming data, changing economic outlooks, and risk balances when discussing monetary policy prospects. This indicates that they rely on the latest information, including soon-to-be-released non-farm data, when making decisions.

Powell did not fully lean towards rate cuts in the July FOMC interview as expected, but retained some hawkish stance, indicating that after seeing the dismal non-farm data for July, he still chose to keep the option of maintaining high rates to suppress inflation, rather than urgently raising rates once to exit the high-rate framework. This also suggests that Powell is not overly worried about a recession in the U.S.

Modern monetary policy theory emphasizes the forward-looking and guiding nature of monetary policy on market expectations. Powell and the Fed's cautious attitude towards rate cuts this time may have absorbed the lessons from the excessive easing in 2020, which spiraled out of control. If a significant rate cut were to occur as the market hopes, it could lead to self-reinforcing market expectations, a sharp decline in Treasury yields, and a resurgence of inflation. Powell and the Fed clearly do not want years of anti-inflation efforts to be undone overnight. He explicitly stated that "we must weigh the risks of acting too early against waiting too long," indicating that while he is prepared to cut rates, he also holds concerns that premature cuts could lead to the failure of forward guidance. Next year's FOMC voting member, the well-known dove, Chicago Fed President Goolsbee, even stated that overreacting to single-month data is unwise, acknowledging the Fed's decision not to cut rates urgently.

II. Weak single-month data does not necessarily point to recession risks

The current state of the U.S. economy can only be described as "slowing growth," and it is difficult to say it is in deep recession. The definition of a recession in the U.S. has always been completed by the National Bureau of Economic Research (NBER), primarily through indicators such as real personal income, non-farm employment, consumer spending, and industrial output.

The NBER has not publicly disclosed its specific judgment criteria, but from the perspective of income and consumption, personal consumption and personal disposable income in June have not changed significantly compared to the beginning of the year. The year-on-year growth rate of personal disposable income narrowed from 4.0% to 3.6%, while personal consumption expenditure increased from 1.9% to 2.6%. At the same time, production output has also improved, and only employment has seen a significant decline, which cannot rule out the influence of temporary factors. Therefore, the U.S. economy is still some distance from a true recession, which is sufficient to support the FOMC's decision not to cut rates in July.

Additionally, recently released data may indicate that the U.S. economy still has potential and growth resilience. The ISM Non-Manufacturing Index for July, released on August 4 (Sunday), and the initial jobless claims data for the week ending August 3, released on August 8 (Thursday), boosted market sentiment. The July ISM Non-Manufacturing Index reported 51.4, exceeding the expected value of 51 and the previous value of 48.8, alleviating some of the extreme panic and sell-off in the market caused by the previous week's ISM PMI and unemployment data. The initial jobless claims for the week ending August 3 reported 233,000, significantly lower than the expected 240,000 and the previous value of 249,000, further reducing market fears of a cliff-like economic recession in the U.S. These generally positive economic data suggest that the U.S. economy is unlikely to be sliding rapidly towards a bottom as pessimistic market prices indicate.

III. The decline in July non-farm data has coincidental factors

In the early hours of July 8 local time, Hurricane "Beryl" made landfall in Texas as a Category 1 hurricane. According to records, this hurricane is the strongest for the same period since 1851 and has become the strongest hurricane globally in 2024 so far. Although "Beryl" began to weaken shortly after making landfall in the U.S., its impact lasted for several days. In the Houston area, approximately 2.7 million households and businesses experienced power outages for several days. Even more than ten days after the hurricane made landfall, tens of thousands of residents and businesses in Texas still had not restored power.

The BLS non-farm report shows that in July of this year, the number of U.S. non-farm workers not participating in labor due to severe weather was 436,000, setting a record for July and more than ten times the average level for July since the BLS began tracking this data in 1976. Additionally, over a million people could only work part-time due to weather reasons, also setting a record for July data, and these informal jobs are likely to have been overlooked in the sampling survey. Although the BLS claims that "the hurricane had little impact on employment data," the economics community and the market generally believe that the BLS's statement does not align with the facts. The significant destruction of the job market caused by the aforementioned hurricane clearly has a huge impact on the new job additions and unemployment rate in the non-farm employment data.

IV. The influx of immigrants and the return of labor constitute structural factors for the rise in the unemployment rate

First, the large influx of illegal immigrants after the pandemic has undoubtedly impacted the domestic labor market. These immigrants are often willing to accept lower wages and working conditions, thereby competing with local workers in the low-skilled labor market. This additional supply and competition not only push up the unemployment rate but may also suppress wage levels in certain industries, putting greater employment pressure on sectors that rely on low-skilled labor.

Secondly, at the beginning of the pandemic, many workers left the labor market due to long COVID symptoms, health concerns, childcare responsibilities, company layoffs, or reduced remote work opportunities. As vaccination rates increased and pandemic restrictions were relaxed, these workers began to reassess their employment situations and gradually returned to the labor market. While this trend is a positive signal for economic recovery, it also means that the number of job seekers available in the labor market has increased, which may lead to a rise in the unemployment rate in the short term.

The unemployment benefits and other fiscal support measures provided by the U.S. government during the pandemic, while offering necessary economic assistance to the unemployed in the short term, may have also reduced their urgency to seek work. As these relief measures are gradually scaled back, workers who originally relied on these benefits are forced to re-enter the labor market, which has also contributed to the rise in the unemployment rate to some extent.

The outward shift of the labor supply curve mentioned above is, in fact, a signal of economic recovery and can have a significant restraining effect on inflation expectations, providing the Fed with more policy space for rate cuts.