Is the United States facing an "employment cliff"?

The fragile market experienced a significant adjustment in July under the impact of weaker non-farm payrolls. Recently, the market has entered a more fragile stage, with the U.S. economy declining more than expected. However, the earliest rate cut will not happen until September. In addition, AI-related companies' performance in the second quarter earnings season did not sustainably exceed expectations. The market has shifted from "bad news is good news" to "bad news is bad news". Before the release of the July non-farm payrolls data, the market had already experienced a significant adjustment.

In July, the U.S. added 65,000 non-farm jobs, bringing the total to 114,000, lower than Bloomberg's consensus expectation of 175,000. The revisions for May and June totaled a decrease of 29,000. The month-on-month growth rate of hourly wages fell by 0.1 percentage points to 0.2%, below the expected 0.3%. The unemployment rate unexpectedly rose to 4.3%, and the labor force participation rate unexpectedly increased by 0.1 percentage points to 62.7%. The average weekly working hours fell to 34.2 hours (Charts 1-3). Although non-farm data itself is volatile, and the July non-farm data may be disrupted by one-off factors such as hurricanes, in the fragile market environment, the market adjustment caused by non-farm data is magnified.

Compared to before the data was released, as of 22:20 Beijing time, the probability of a rate cut in September is 100%, with the cumulative probability of rate cuts for the whole year increasing by 24 basis points to 112 basis points. The 2-year and 10-year Treasury yields fell by 22 basis points and 12 basis points to 3.89% and 3.81% respectively. The U.S. dollar index fell by 0.8% to 103.2, and the three major U.S. stock indexes fell significantly, with the Nasdaq falling by more than 3%.

• In July, the significant decline in new non-farm employment was mainly dragged down by the service sector, while government employment also weakened. In July, private sector new non-farm employment fell by 39,000 to 97,000 compared to June, hitting a new low since March 2023. This was mainly due to a decrease of 53,000 in new employment in the service sector to 72,000 compared to June. Specifically, except for the retail and leisure hotel sectors, employment in other service sectors declined, with significant decreases in education and health care, information, and other service industries, decreasing by 22,000, 21,000, and 17,000 respectively. In the goods sector, new non-farm employment in July increased by 14,000 to 25,000 compared to June: durable goods manufacturing and construction increased by 13,000 and 5,000 respectively, while non-durable goods manufacturing and mining slightly decreased (Chart 5). Government employment decreased by 26,000 to 17,000, approaching the second quarter's 18,000 per month, continuing to slow down from the first quarter's 64,000 per month.

• In July, the month-on-month growth rate of hourly wages fell by 0.1 percentage points to 0.2%, lower than expected, with a significant decline in wages in the goods sector and a slight increase in wages in the service sector. Specifically, hourly wages in the goods sector increased by 0.25 percentage points to 0.2% month-on-month, except for the construction industry, where wages generally weakened. Hourly wages in the service sector slightly increased by 0.03 percentage points to 0.26%, mainly due to utilities (up 0.63 percentage points to 0.24%) and information services (up 0.32 percentage points to 0.73%) Boosted by the financial industry (up 0.4pct to 0.35%), the overall wage level in other service industries remained flat or slightly slowed down.

The current market is entering a stage that pressures the Fed to accelerate the pace of interest rate cuts. Under the baseline scenario, we believe the Fed will cut interest rates by 25bp for the first time in September and 2-3 times throughout the year. In the July FOMC meeting, Powell clearly stated that if the data allows, the earliest rate cut would be in September, and he repeatedly expressed concerns about the slowdown in the labor market. The July non-farm payroll data led to the market pricing an 80% probability of a 50bp rate cut on September 18th, partly because the market is currently in a window of expected deterioration: there is still a month and a half until the September meeting, even if economic data significantly weakens, the Fed cannot react earlier, increasing the risk of the Fed falling behind the curve, so short-term fluctuations may be difficult to avoid. If the market continues to decline, it may force the Fed to increase the size of the rate cut. However, considering that the July non-farm payroll data was partly disturbed by one-off factors, exaggerating the weakness in the labor market, and the Fed has a significant room for rate cuts, given time, after the Fed adjusts its policy, the U.S. economy still has the potential for a soft landing. The Fed has also emphasized multiple times that it cannot rely on individual data for decision-making. Therefore, under the baseline scenario, we still believe that the Fed will cut interest rates by 25bp for the first time in September and the total rate cut will be 2-3 times throughout the year (see "July FOMC: Fed Indicates Data Supports Rate Cut in September", 2024/8/1).

• The weakening of the July non-farm payroll data and the unexpected rise in the unemployment rate indicate a gradual "normalization" of the labor market. Since the epidemic, the "labor shortage" in the U.S. labor market has led to companies hoarding labor (labor hoarding) (see "When Will the U.S. Labor Shortage Ease?", 2023/1/2), resulting in a decrease in job vacancies in the U.S. labor market since 2023, but a "abnormal phenomenon" of little change in the unemployment rate (Chart 6). The reason behind this is that as the U.S. economy gradually cools down from overheating, companies are mainly responding to changes in demand by slowing down recruitment (reduction in job vacancies) rather than layoffs (recruitment and quit rates are low). As of June 2024, both the recruitment rate and quit rate of companies have dropped to levels not seen since 2016 (Chart 7). However, since the beginning of the year, as job vacancies and the unemployment rate have almost returned to pre-epidemic levels, the ratio of job vacancies to unemployed persons (v/u) has also returned to pre-epidemic levels (Chart 8), the slowing down of job demand has gradually pushed up the unemployment rate. Therefore, the slowdown in new non-farm employment and the rise in the unemployment rate are in line with previous expectations, indicating a gradual normalization of the labor market.

• However, considering the significant fluctuations in non-farm data, the July non-farm data may have exaggerated the slowdown in the labor market. Looking at the 3-month moving average, the new non-farm employment in July was 170,000, which is basically flat compared to June (Chart 9); in April 2024, new non-farm employment once dropped to 108,000, then rebounded to 216,000 and 179,000 in May and June (Chart 9); the layoff rate in June 2024 remained at a low level (Chart 10) In addition, although the Bureau of Labor Statistics (BLS) believes that the hurricane that hit Texas on July 8 had no significant impact on the July non-farm data, the number of people who missed work due to severe weather reached 580,000 (Chart 11), raising the possibility that the hurricane's impact on unemployment may exceed BLS's expectations.

Author: Yi Yan (S0570520100005), Source: Huatai Securities Research Institute, Original Title: "Macro: Is the United States Facing an 'Employment Cliff'?"