Last week, financial markets were concerned about the upcoming employment report, leading to lower prices in both equity and fixed income markets. Despite Friday’s strong employment report, which slightly eased the market’s worries, Nasdaq fell by 0.8%, the S&P 500 by 1.0%, and the Dow Jones Industrials by 2.3%. The underperformance of the Dow Jones Industrials may be attributed to issues in the manufacturing sector that have been hinted at for several months.
There is a significant discrepancy between the Non-Farm Payrolls (NFP) and the Quarterly Census of Employment and Wages (QCEW) data. The NFP reports show five million more jobs than the QCEW report does. Additionally, the Birth/Death (B/D) model adds approximately 100K jobs to the NFP report, which has created doubts about the accuracy of the job growth numbers. Full-time job losses are concerning, with the QCEW data indicating a decline of 284K full-time jobs over the past year.
The brewing Commercial Real Estate Loan crisis could lead to a banking crisis. Leveraged loan delinquencies exceed 6%, office vacancies are at record highs, and CRE prices are declining. Banks hold half of all CRE debt, and as foreclosures in the CRE space increase, loan loss reserves are expected to rise, impacting the financial condition of banks. It is anticipated that the Fed may intervene with a special lending facility as the crisis spreads, which could lead to a recession.
The Federal Reserve has indicated that more progress on inflation is needed before they consider lowering rates. Interest rates have increased, with the 10-Year Treasury yield rising from 3.79% to 4.38%. Despite this, some believe that rent increases, which account for a significant portion of the Consumer Price Index (CPI), will have a neutral to negative impact on inflation. Fed Chair Powell has mentioned the possibility of cutting rates this year, but market odds of a rate cut in May are slim.
The employment numbers, though seemingly strong, have underlying issues such as the disappearance of full-time jobs and discrepancies between NFP and QCEW data. The growing CRE problems and the potential impact on banks suggest another crisis may be looming. While the Fed has indicated that rates will be higher for longer, there is also talk of potential rate cuts in 2024. However, the upcoming impact of falling rent on inflation and the banking system’s vulnerabilities may necessitate quicker rate cuts.
Overall, the current economic climate is uncertain, with concerns about job growth accuracy, a looming banking crisis, and inflation fluctuations. As markets react to incoming data and Fed statements, it remains to be seen how policymakers will navigate these challenges to steer the economy in a stable direction.
