Latest Payroll Numbers Overshadow Improving Inflation Data

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

What was shaping up as a solid week for investors got sidetracked after the Bureau of Labor Statistics (BLS) came out with Nonfarm Payrolls data that showed hiring in July exceeded even the most optimistic expectations. The report showed 528,000 jobs were added last month, more than double the consensus estimates. Hiring was widespread, with the services sector seeing the largest jump. Additionally, wages rose 5.2 percent, which was more than expected, and the labor force participation rate inched lower.

Wall Street viewed the news as a sign the economy is still too hot and that the Federal Reserve will need to maintain its aggressive posture on rates. While the number of new hires was noteworthy, it’s important to remember employment is a lagging indicator in the economy — meaning many of the reported new hires may have already been in the midst of the hiring process when the economy was still humming along.

Perhaps more striking than the actual number of new jobs is the divergence between the Nonfarm Payrolls report and BLS’s other measure of employment, the so-called Household report. During the past four months, the Nonfarm Payrolls measure has pointed to 1.7 million new hires, while the Household report registered a loss of 168,000 jobs. With the exception of the early months of COVID, the current difference between reports is the greatest since 1960. We believe the yawning gap between the measures will eventually tighten and expect the data will show a labor market that is cooling.

Underscoring this point was last week’s Jobs Openings and Labor Turnover Survey, also from the BLS, which showed job openings were down 605,000, or 5.3 percent, from the prior month. Since hitting 11.86 million openings in March of this year, job openings have shrunk by 1.16 million positions. As the economy continues to slow, we expect the number of openings to fall further and believe some industries that hired aggressively following the end of COVID lockdowns may cut payrolls or halt hiring as they look to grow into expanded production capacity.

As we’ve noted in the past, a single data point rarely tells the full economic story. Other reports out during the week suggest growth continues to slow and, more importantly, inflationary pressures are cooling. When looking at all inputs, we believe it is probable the economy will enter a recession later this year or in early 2023 — an outcome the market appears to have already priced in and is willing to accept if it leads to continued slowing of prices pressures.

Wall Street wrap

The surprising strength of the Nonfarm Payrolls report overshadowed several measures during the week that pointed to notable improvements in some of the cost measures businesses are facing, as well as further signs that the supply/demand imbalance that has plagued the economy since the height of COVID is healing.

Slowing cost pressures and improving inventories: The latest manufacturers data from the Institute for Supply Management (ISM) showed cost pressures continue to be elevated; however, the latest reading of 60 percent is down 18.5 percentage points from June’s level of 78.5. It’s worth noting the measure was as high as 92 in the summer of 2021. The latest figure is the lowest since August 2020. Additionally, supplier delivery times fell to 55.2 – meaning bottlenecks are clearing. For context, the delivery time measure stood at 78.8 last summer and was at 65 in January. Improving delivery times bolstered inventory readings to 57.3, up from June’s level of 56. Supply chain and cost measure are now near long-term averages and highlight substantial progress in addressing the scarcity of goods that has helped fuel rising prices.

While the report was mostly positive, it did offer a potential recessionary warning. New orders came in at 48.0, which is 9.3 points below inventory levels — the gap between the two readings is at a level that has coincided with previous recessions. However, customer inventories remain low at 39.5 and indicate future production is needed to refill store shelves.

The transition to services regains its footing. While manufacturing cooled, the services side, which makes up the bulk of the U.S. economy, remains strong and showed growth, according to the latest numbers. As we’ve noted in the past, industries that were COVID “beneficiaries,” such as manufacturers and retailers of goods, have taken the brunt of the slowdown as consumers have shifted spending toward experiences and services. While that trend slowed earlier this summer as COVID cases escalated, the latest data on services from the Institute for Supply Management show the pace has reaccelerated, with the July reading for services coming in at 56.7, up from June’s level of 55.3. For context, readings above 50 are considered expansionary.

The report also showed that supply bottlenecks and costs are easing, which should dampen inflation pressures in the coming quarters. Additionally, the difference between new orders and inventory sentiment remains in positive territory and suggests continued growth in production and a source of strength for the overall economy.

Strong earnings season. As earnings season winds down with 431 of the S&P 500 companies announcing quarterly results as of late last week, earnings have been strong — in aggregate 75 percent of companies beat estimates and did so by an aggregate of 3.8 percent. Of note, strength was widespread; every industry beat expectations. Revenues were also strong, with 64 percent of companies reporting better than expected sales and exceeding expectations by an aggregate of 3 percent. Forward estimates came down marginally but are not in line with expectations of a significant recession.

The week ahead

• Tuesday: NFIB Small Business Optimism Index readings for July will be out before the opening bell. The report should provide an update on the future for labor costs as well as signs on the direction of prices at both the consumer and wholesale levels.
• Wednesday: The big report for the day will be the Consumer Price Index (CPI) report from the Bureau of Labor Statistics, as the markets will be scrutinizing the report for signs that slowing growth is having a cooling effect on prices.
• Thursday: Following on the heels of the CPI report comes data on the Producer Price Index. The report will offer insights into whether businesses are seeing any relief on costs that may translate into a break for consumers’ pocketbooks going forward.
• Friday: The University of Michigan will release its preliminary report on August consumer sentiment as well as inflation expectations. With recent hot readings from both the Consumer Price Index and Personal Consumption Expenditures index, we’ll be monitoring to see whether inflation expectations for the future are drifting higher or remain anchored.

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