4 Alpha Research Researcher: Kamiu

Opinions in a nutshell

• The market overreacted, reflecting Wall Street's consistent mentality of making a bigger reaction to the failure of interest rate cuts. The Federal Reserve has its own clever tricks.

• The rise in unemployment in July was due to temporary factors such as hurricanes

• There are structural reasons why the unemployment rate and new employment in July were significantly worse than expected, but this may not be a completely bad thing for the US economy: immigrants and workers who have left the labor force returning to the market will help to curb inflation in the long run.

1. The market may have overreacted 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 when facing the risk of recession has always been greater than its pursuit of hawkish policies when faced with the risk of economic overheating and inflation. In other words, the U.S. market's "elasticity" to interest rate cuts is always higher than its "elasticity" to interest rate hikes, and the risk preference for inflation is higher than the risk preference for deflation.

The July FOMC resolution did not cut interest rates ahead of schedule as the most optimistic observers had expected. The U.S. market, which had priced in this expectation in advance, did not crash after the announcement of the resolution, which may have been the last bit of kindness. The plunge in prices of almost all major assets after the non-farm data that was significantly lower than expected vented the market's dissatisfaction with the Fed's "slow action". Musk even bluntly said, "It would be stupid for the Fed not to cut interest rates in July."

Under this sentiment, the spiral plunge caused by the stampede of long positions cannot fully explain that the US non-farm employment in July directly points to a hard landing and a cliff-like recession.

The Fed probably does not think that the United States is already facing a huge risk of recession. It is generally believed that the FOMC voting members of the Federal Reserve can see some economic data for the month before voting, although these data are usually limited. According to the minutes of the Federal Reserve meeting, when discussing the outlook for monetary policy, officials will emphasize the need to make future decisions based on upcoming data, the changing economic outlook and the balance of risks. This shows that they will rely on the latest information when making decisions, including the non-farm data that will be released soon.

In the July FOMC interview, Powell did not completely turn to rate cuts as expected, but retained a hawkish stance. This shows that after seeing the dismal non-farm data in July, he still chose to retain the option of continuing to use high interest rates to curb inflation, rather than an emergency rate hike in July to exit the high interest rate framework all at once. It also shows that Powell is not overly worried about the US recession.

Modern monetary policy theory emphasizes the forward-looking and guiding role of monetary policy for market expectations. Powell and the Federal Reserve he leads may have learned from the lesson of the excessive and uncontrollable opening of the floodgates in 2020. If the market expects a sharp interest rate cut this time, it may lead to self-reinforcement of market expectations, a sharp drop in Treasury yields, and a resurgence of inflation. Powell and the Federal Reserve obviously do not want to lose all their efforts to fight inflation overnight. He himself clearly stated that "the risks of acting too early and waiting too long must be weighed", indicating that while he is ready to cut interest rates, he also holds concerns that a premature interest rate cut may cause the forward guidance to fail. Goolsbee, a well-known dovish official and chairman of the Chicago Fed, who will be a voting member of the FOMC next year, even said that it is unwise to overreact to the data for a single month and recognized the Fed's decision not to cut interest rates urgently.

2. Weak data in a single month does not necessarily point to recession risk

The current state of the US economy can only be described as "slowing growth" and it is difficult to say that it is a deep recession. The definition of the US economic recession period has always been completed by the National Bureau of Economic Research (NBER), which mainly defines the recession period through indicators such as personal real income, non-agricultural enterprise and household survey employment, consumer expenditure, and industrial output.

NBER did not actually publish its specific judgment criteria, but from the perspective of income and consumption, personal consumption and personal disposable income in June did not change much compared with the beginning of the year. The year-on-year growth rate of personal disposable income narrowed from 4.0% to 3.6%, and personal consumption expenditure increased from 1.9% to 2.6%. At the same time, production output also improved. Only employment fell sharply, and the influence of accidental factors cannot be ruled out. Therefore, the US economy should still have a buffer distance from a real recession, which is enough to support the FOMC not to cut interest rates in July.

At the same time, other data released recently may indicate that the potential and growth resilience of the US economy remain. The July ISM non-manufacturing index released on August 4 (Sunday) and the first-time unemployment claims data for the week of August 3 released on August 8 (Thursday) boosted market sentiment. The July ISM non-manufacturing index was 51.4, exceeding the expected value of 51 and the previous value of 48.8, which to some extent alleviated the market's extreme panic and stampede caused by the ISM PMI and unemployment data of the previous week; the first-time unemployment claims for the week of August 3 were 233,000, significantly lower than the expected 240,000 and the previous value of 249,000. The market's panic about the US falling into a cliff-like economic recession has further eased. These generally positive economic data show that it is highly likely that the US economy will not slide to the bottom as quickly as the pessimistic market prices show.

3. The decline in non-agricultural data in July was due to accidental factors

In the early morning of July 8, local time, Hurricane Beryl made landfall in Texas, the United States, as a Category 1 hurricane. According to records, this hurricane is the strongest hurricane of the same period since 1851, and it has also become the strongest hurricane in the world since 2024. Although Beryl began to weaken soon after landing in the United States, its impact lasted for many days. In the Houston area, about 2.7 million households and businesses experienced power outages for several days. Even more than ten days after the hurricane landed, tens of thousands of residents and businesses in Texas still had no power supply restored.

The BLS non-farm report shows that in July this year, the number of non-agricultural employees in the United States who did not participate in the labor due to bad weather was 436,000, which set a record for July and is more than 10 times the average level of July in each year since the BLS began to collect this data in 1976. In addition, more than 1 million people can only work part-time due to weather reasons, which also set a record for July data in previous years. These informal jobs are likely to be missed in the sample survey. Although the BLS claims that "hurricanes have little impact on employment data", the economics community and the market generally believe that the BLS's statement is inconsistent with the facts. The great damage to the job market caused by the above-mentioned hurricanes obviously has a huge impact on the number of new jobs and unemployment rate in non-agricultural employment data.

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

First, the massive influx of illegal immigrants after the pandemic has undoubtedly had an impact on the local labor market. These immigrants are usually willing to accept lower wages and working conditions, thus competing with local workers in the low-skilled labor market. This additional supply and competition not only pushes up the unemployment rate, but may also lower the wage level in certain industries, making those industries that rely on low-skilled labor face greater employment pressure.

Secondly, at the beginning of the epidemic, many workers left the labor market due to sequelae of COVID-19, health concerns, childcare responsibilities, company layoffs or reduced opportunities for remote work. As vaccination rates increase and epidemic restrictions are relaxed, these workers are beginning to reassess their employment status and gradually return to the labor market. Although this trend is a positive sign for economic recovery, it also means that the number of job seekers available in the labor market has increased, which may lead to an increase in unemployment in the short term.

The unemployment benefits and other fiscal support measures such as MMT provided by the US government during the epidemic, while providing necessary financial assistance to the unemployed in the short term, may also reduce their urgency to find a job. As these relief measures are gradually reduced, workers who originally relied on these benefits are forced to re-enter the labor market, which to some extent has also led to a rebound in the unemployment rate.

The outward shift of the above-mentioned labor supply curve is actually a signal of economic recovery, and it is expected to have a more obvious curbing effect on inflation, which can provide the Federal Reserve with more policy space for interest rate cuts.