September rate cut on the horizon: How US jobs and inflation shape the Fed’s next move

Jobs revisions underline Fed’s September rate cut

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What the chart shows

The chart displays the annual revisions of US nonfarm payrolls through April-March cycles from 1980 to 2024, highlighting the negative revision average, revision’s 5^th percentile, and percentage point errors.

Behind the data

The US nonfarm payrolls were revised downward by 818,000 jobs over the 12 months through March 2024, a 0.5% reduction from the original total figures.

This marks the largest downward revision since 2009, far exceeding the average negative revision of 243,000 and even surpassing the 95%-confidence Value-at-Risk (VaR) estimate of 602,000. It underscores growing concerns about the strength of the US labor market.

However, the negative revision was not significantly above Bloomberg’s estimate of 730,000 and less severe than the upper-bound prediction of 1m.

As Federal Reserve (Fed) Chair Powell will deliver his crucial speech at the Jackson Hole Symposium, the jobs revision will play a role in determining rate cuts looking ahead, broadly anticipated to begin in September.

Persistent cyclical core PCE poses risks to Fed’s easing cycle

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What the chart shows  

The chart illustrates the decomposition of US core PCE inflation into cyclical-acyclical and demand-supply components. It also compares these to pre-COVID averages for cyclical and demand-driven contributions.

Behind the data

US core PCE inflation is one of the Fed’s inflation gauges in considering monetary policy implementations, while the central bank is facing moderation in inflation and jobs and is poised to enter an easing cycle. The cyclical and demand-driven parts may associate more with the Fed than other considerations. This is because cyclical inflation reflects overall economic conditions instead of industry specifications, while the Fed controls demand rather than supply.

Recently, compared to pre-COVID norms, the US core PCE inflation has remained in excess in cyclical aspects despite normalization in demand-driven factors. So, there still exist inflationary risks.

US GDP growth surpasses expectations despite weak leading indicators

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What the chart shows  

The chart compares the year-over-year growth of US real GDP with that of the Leading Economic Index (LEI). It also illustrates LEI averages during recession periods and at the start of recessions and GDP-LEI z-score differentials.

Behind the data

US GDP growth for Q2 2024 exceeded expectations, led by strong private consumption and inventory accumulation. With the upcoming second estimate on August 29, the LEI—which includes economic and financial components such as new manufacturing orders, consumer expectations for business conditions, and the S&P 500—typically serves as an indicator of economic activity and potential recessions.

However, recent years have revealed discrepancies between GDP and the LEI, with the LEI contracting despite solid GDP growth. Although the LEI has recently risen above recessionary norms, it remains below levels typically observed at the start of recessions.

Amid the potential for avoiding a recession, the alignment between macroeconomic and sentiment indicators remains debatable.

Sectoral sentiment in the Eurozone reflects mixed economic outlook

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What the chart shows  

The chart presents the recent z-scores and distributional statistics of the Euro area’s economic sentiment composite, covering five sectors from the EU Business and Consumer Surveys.

Behind the data

Aside from the economic stagnation for over a year, the eurozone's economic sentiment has remained relatively low, hovering around the 25^th percentile. By sector, sentiment in industry, services, and among consumers is also pessimistic, with industry sentiment worsening, while consumer sentiment has improved over the past 12 months. Additionally, retail and construction sentiment has declined over the past year, with retail near the median and construction moderately above it.

With mixed sentiments across economic sectors and a low composite level, the euro area seems struggling to turn optimistic.

Changing correlations highlight varied investment dynamics

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What the chart shows  

This chart examines the relationship between the average monthly total returns of the S&P 500 and 10-year Treasury notes over various time periods. It illustrates how the correlation between US stocks and bonds varies based on the time horizon, ranging from one year to 50 years, with values between these points interpolated linearly.

Behind the data

In the short term, such as one year or less, the returns of stocks and bonds are positively correlated, meaning they tend to move in the same direction. However, as the lookback period extends, this correlation decreases, indicating a weakening relationship.

Beyond a 10- to 30-year lookback horizon, the correlation between the two assets turns negative, providing investors with opportunities for diversification. After that, it gradually returns to positive figures. This pattern suggests that the relationship between the monthly returns of stocks and bonds varies significantly depending on the time frame considered, underscoring the importance of considering different time horizons when analyzing the interaction between these two key asset classes.

Consumer discretionary and IT sectors lead, while energy and materials lag

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What the chart shows  

The chart depicts sustainable growth rates (SGRs) across S&P 500 sectors, representing the maximum rate of growth a company can achieve using internal revenue without external borrowing.

It is calculated as the return on equity (ROE) times the retention ratio, which is the proportion of earnings retained in the business as retained earnings.

Behind the data

SGRs across S&P 500 sectors reveal a contrast: the consumer discretionary sector is currently achieving an all-time high SGR, indicating long-term growth potential without the need for external financing. The information technology sector also shows above-average performance, countering concerns about lost momentum, particularly for companies like Nvidia. In contrast, sectors like energy and materials are showing much weaker SGRs compared to last year, signaling a more challenging outlook for these industries.

Foreign outflows reflect persistent pessimism towards Chinese equities

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What the chart shows  

The chart visualizes the CSI 300 index and net foreign equity flows, derived from the Shanghai and Shenzhen Hong Kong Stock Connect, with data on both Northbound and Southbound flows.

Behind the data

Net negative cumulative equity flows from overseas could reflect pessimistic sentiment and exert downward pressure on Chinese stock performance. This trend is evident in 2021-23, where cumulative net flows were negative, and the stock index closed lower than at the beginning of the year. Meanwhile, other factors, such as the 2018 trade war and the country's first-in, first-out approach to COVID in 2020, may have also had impacts in earlier years.

Additionally, 2024 has been a challenging year for Chinese economic expectations and equity performance. Amid existing economic challenges, exchanges in China have stopped reporting certain sentiment data, including flows, underpinning reduced availability of economic indicators.