Mixed Messages
The October employment report was quite disappointing, but also artificially depressed by hurricanes and the Boeing strike. Superficially, it came close to stagflation. Immediately after the election, the Fed will decide if it wishes to reduce interest rates again. The market fully expects and is priced for another 0.25% reduction, but that case seems weak. As typically happens in the fourth year of a Presidential term, investors poured money into bonds due to the inherent uncertainty of the vote outcome. But once the outcome is known, they invariably move into equities. We suspect that same behavior will be seen this time, as well.
The part of the jobs report that really was weak were the downward revisions to recent months, although that may have also been influenced by the Boeing strike. Hurricane Milton, the second of the two storms, arrived October 9 and some businesses shut down and people evacuated shore areas in the days before that. As noted by the Bureau of Labor Statistics, they have no way of identifying just how many jobs may have been reduced by the hurricane or the strikes. Taken at face value, the average for the latest three months is now just 104,000. This is not impressive, but also not awful. If the workers approve the Boeing contract offer on Monday, employment will rebound in the November jobs report. Rebuilding efforts from the storms will take longer, because some firms will never reopen. But there is also a surge in hiring taking place to make repairs or to rebuild. At a minimum, the storms will provide a boost to GDP, however illogical that may sound.
Amid all this cacophony, as well as the uncertainty surrounding the election, the Fed must decide what to do about policy. The justification for the 50-basis point rate reduction at the September meeting was that it provided a floor or insurance against a weakening labor market. The need for such an insurance policy had been greatly undermined by the string of strong economic reports that followed, including retail sales, GDP, unemployment claims and others, which implies that further rate reductions were not needed to shore up the economy. Nonetheless, we know that a number of Fed officials remain concerned about the downside risk to the economy, so they prefer another rate reduction. But others at the Fed may not be comfortable lowering rates when economic growth remains robust. And wage inflation remains a concern, since it still it seems stuck at around 4.0% at an annual rate, which will be a hurdle to any further decline in price inflation. The wage agreement about to be struck at Boeing follows on the large wage increases for auto workers, airlines and dockworkers, among others. So, we suspect the policy vote is likely to be close. As with the presidential election, we will soon see how it goes.
The strong performance of the economy is supporting the solid earnings reports of companies for the third quarter. That’s the key foundation for stock market valuations. The market’s 20% gains in 2024 depends crucially on ongoing increases in corporate profits and interest rates remaining at least moderate. So, the rise in long-term interest rates following the Fed’s 50 basis point rate reduction serves as a warning to the Fed and market participants that investors are no longer confident that long-term bonds are a safe investment. The fiscal programs proposed by both presidential candidates would worsen the budget deficits, which would add to the upward pressure on longer term interest rates.
Nonetheless, it is premature to judge whether and how much of the proposed fiscal programs will actually be implemented. Even if one party sweeps, they may lack sufficient votes to fully implement the program of the victor, especially since a filibuster still requires a 60% vote to overcome it. But if there is no sweep, divided government has proven to be fairly positive for stock market performance, even if it prevents either party from getting their agenda passed. That’s just another of the many uncertainties for investors and a contributing factor to the upward pressure on long-term interest rates that may require some time before there is clarity.
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