Under the Surface: Job Growth Slows, but Trend Still Firm as Fed Policy Eyed

> A volatile week comes to a close with a monthly jobs report that fell a bit short of consensus estimates. But the unemployment rate fell to a level not seen since 1969. How might this reflect on the U.S. consumer and on Fed policy?

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5 min read
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Key Takeaways

  • Jobs growth of 136,000 in September misses estimates, but three-month average solid

  • Costco shares head lower after earnings miss, but same-store sales solid

  • Bond market rally continues, a potential sign that caution remains high

  • Volatility eases, but still elevated relative to recent days

(Friday Market Open) The blistering jobs growth of 2017 and 2018 is definitely in the rear-view mirror. September’s eagerly awaited monthly payrolls report showed just 136,000 new positions added, the lightest gain since May.

That was below expectations for around 150,000, but it doesn’t mean there’s nothing to be cheerful about going into the weekend. For one thing, the government upwardly revised estimates for July and August job gains, adding 45,000 positions it hadn’t previously reported and bringing the August number up to 168,000. If you look at the more important three-month average, it’s at 157,000. 

While 157,000 isn’t as strong as the 200,000 many investors got used to a year or two ago, it’s nothing to sneeze at, either. With unemployment falling another 0.2 percentage points to 3.5% in September—the lowest since December 1969—there probably just aren’t as many people out there who need jobs. That tends to slow new hiring, but a 157,000-pace is more than enough to keep up with growth in the labor pool, many economists say.

Slower job  growth also arguably means less chance of the economy overheating, according to some analysts. That could mean less pressure on the Fed to worry about inflation caused by a swelling labor force demanding higher pay. If the Fed doesn’t have that to deal with, it could leave it more willing to lower rates.

Stock futures, which had been down before the report, started to turn a little higher right after the data appeared. Even before the report came out, odds of a rate cut later this month had been zooming up in the futures market, and that was one of the supporting factors in yesterday’s rally. This kind of a vanilla jobs report isn’t likely to change that trend in Fed funds futures. Surprisingly, though, the futures market odds of a 25-basis point rate cut fell to below 80% right after the data from around 90% late on Thursday. 

Despite the low unemployment, wages barely changed in September from a month earlier, the Labor Department said. That could be another sign that inflation might not be too problematic right now. 

One thing that might get some people worried, though is that wages rose just 2.9% year-over-year in September after staying above 3% for months in a row. Any sign of slower wage growth could feed into fears about whether the economy might be starting to slow. This week’s manufacturing and service numbers were both weak, and that led to some economists wondering if a slowdown in business growth could lead to slower wage growth, leading to slower consumer demand.

We’d probably need to see wage growth weaken for more than one month to get a read on that, but it’s something to consider keeping in mind when the October jobs data come out.

Job category growth was strongest in health care, with 39,000 new positions, the government said. Business and professional services employment also grew firmly. Transportation was on the leaderboard, too. However, the sectors many watch closely for signs of economic strength, like manufacturing and construction, didn’t show much change in September. Those are categories where you like to see strong growth, because it can sometimes signal underlying firmness in demand from businesses and consumers and those tend to be long-lasting, higher-paying positions.

Rate Cut Hopes Helped Spur Yesterday’s Recovery

Before payrolls took the spotlight, stocks staged a bit of a recovery Thursday following the feverish selling we saw on Tuesday and Wednesday. Every sector rose, just like every sector fell the day before. Things looked pretty strong across the board, but Technology, Energy, and Real Estate topped the list. Growing hopes for a Fed rate cut this month seemed to get investors back in a buying mood despite soft data (see more below).

By the end of the day Thursday, CME Group futures put odds of an October rate ease at nearly 90%, up from 50% a week earlier. As noted above, it fell below 80% on Friday, but that’s still relatively high. It’s rare to see the chances shoot up so quickly. At the same time, odds of an additional rate cut after October and before the end of the year now stand at better than 50%, compared with below 20% a week ago. The manufacturing data earlier this week, along with weak data overseas, might be turning the tables on expectations around the Fed. Growing worries that problems in Europe and Asia could start to weigh on U.S. consumers probably raised rate cut hopes. 

One day in the green certainly doesn’t mean investors are out of the woods as far as how stocks perform. That’s pretty easy to tell if you look at what bonds and gold did Thursday. Even as stocks rolled higher, 10-year Treasury yields sank back below 1.54% for the first time in a month, and gold also got a slight lift.

Despite Rally, Cautionary Stance Remains Evident

With stocks and bonds moving higher Thursday, one possible takeaway could be that many investors were playing both sides of the market. They’re dipping their toes into some of the potentially turbulent cyclical sectors again, but at the same time keeping another foot in the shallow end of the pool where the water feels safer. It also could signal a willingness to jump back into more defensive investments with both feet if the data news doesn’t perk up. We’re still two weeks out from earnings season, so the Fed, data, and geopolitics are more likely to tell the story for a while.

Economic worries continue to show up in the crude market, which is now down 16% from the mid-September highs it reached when Saudi Arabia’s oil facilities got bombed. U.S. crude oil futures are near two-month lows under $53 a barrel, and supplies look plentiful at the moment. Sometimes pressure on crude reflects concerns about weak economies causing relaxed demand.

Volatility hasn’t relaxed much despite yesterday’s rally in stocks. The Cboe Volatility Index (VIX) did edge below 20 on Thursday, but only by a little. Volatility could be back in the picture today as traders position themselves for the end of the week in this topsy-turvy geopolitical time. The question is whether people will feel comfortable entering the weekend with long positions, especially considering that trade talks between the U.S. and China start again next week and the impeachment proceedings with all the headlines they generate continue in Washington.

Going into next week, investors are likely to continue processing what this jobs report might mean for the broader economy and the markets. They’re also eyeing those trade talks, scheduled to start Oct. 10. Things could be on tenterhooks once those talks start, because there’s muscle memory of the disappointing end to negotiations back in May. No one seems too sure whether China and the U.S. can get past the same sticking points that tripped them up last time. Though China seems willing to buy more U.S. products, especially agricultural ones, the intellectual property issue keeps getting in the way of further progress.

Bouncing Off Support Again and “WATCHING” Costco

From a technical standpoint, Thursday’s action might have been constructive. That’s because after an early dip, the S&P 500 Index (SPX) again stayed above its 200-day moving average. It hasn’t been under that since early June, and then only for a few days. The 200-day now stands at 2839, and that likely would continue to represent a solid technical support level, analysts said. 

Over on earnings row, Costco (COST) shares fell slightly in pre-market-trading Friday after the company’s revenue rose 7% year-over-year, but came in slightly below consensus estimates. On the positive side, same-store sales rose a solid 5.1%, though that was just below estimates, too. COST’s revenue could be under pressure from growing competition that’s forcing down prices, analysts said.

COST is one of the so-called “WATCH” companies that get closely monitored as barometers of consumer health. The WATCH group also includes Walmart (WMT), Amazon (AMZN), Target (TGT), and Home Depot (HD). Between the five, you’re talking more than $1 trillion in annual revenue, so it’s probably fair to say that incorporates a big chunk of overall U.S. consumer spending on everything from Christmas gifts to groceries to clothing to household items like washing machines and televisions. AMZN is likely to be the next of those companies to report later this month.

WORKING WITH A NET? You never want to get complacent about something as complex as technical support areas. However, as this six-month chart of the S&P 500 Index (SPX-candlestick) demonstrates, the 200-day moving average (blue line) has continued to hold up pretty well. This happened again Thursday, when the SPX perked up quickly after approaching this long-term technical area. If it does get broken for more than a few days, sellers might get bolder, but that’s never a certainty. The SPX bounced back pretty fast when it last dipped below the 200-day in June. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results.

Services Sector Slowdown: Do you want the good news or the bad news first? The good news is that the latest data on the U.S. services sector, which represents about 90% of the domestic economy, showed continued expansion. The bad news is that it expanded at a slower pace than was expected. The ISM non-manufacturing index for September dropped to 52.6 from 56.4 the previous month. A Briefing.com consensus had expected the latest reading to come in at 55.4. That slowdown in growth could be worrisome considering the huge chunk of the economy that the services sector makes up. The slowdown “is fanning concerns that the manufacturing recession, and trade uncertainty, are having a broader effect on the consumer-oriented services sector,” Briefing.com said.

Business Spending Slips: While yesterday brought investors news that the services sector is growing less than expected, they also got another peek into the manufacturing sector. And it didn’t look good, continuing a week of sluggish data from the factory floor. U.S. factory orders for August fell 0.1% when a Briefing.com consensus had expected no change. The new print was well off from the 1.4% increase we saw in July.

This comes after this week’s disappointing ISM U.S. manufacturing purchasing managers’ index reading of 47.8% for September, which was the lowest since June 2009 and marked the second month in a row where the index contracted. Of particular concern in the latest factory orders report is that a proxy for business spending, measured by orders for non-defense capital goods excluding aircraft, fell further than the headline figure, dropping 0.4%. When coupled with the ISM manufacturing data, the factory orders figure could also help play into expectations for another rate cut from the Fed this month. Of course, today’s jobs figure also plays into that equation.

Looking Toward Inflation Data: With the jobs report out of the way, arguably the next big data points investors could eye closely are next week’s readings on inflation. Those come in the forms of producer and consumer price indexes. With the U.S. manufacturing sector in contraction and the services sector growing more slowly than expected, readings that come in below expectations have the potential to boost the market on strengthened expectations of a Fed rate cut. The Fed generally doesn’t want to lower rates in an environment of rising inflationary pressure (and serious inflation hasn’t really shown up in a long time). But it may want to be more dovish to stimulate a weakening economy. So a combination of weak manufacturing, a slowdown in the services sector, and lower or muted inflation could play into expectations of easier monetary policy from central bankers.

Good Trading,

JJ

@TDAJJKinahan

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This week's economic calendar. Source: Briefing.com
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Key Takeaways

  • Jobs growth of 136,000 in September misses estimates, but three-month average solid

  • Costco shares head lower after earnings miss, but same-store sales solid

  • Bond market rally continues, a potential sign that caution remains high

  • Volatility eases, but still elevated relative to recent days

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