Why Luke Lango says last week’s blazing jobs report was actually soft … what is the Sahm Rule telling us? … Louis Navellier on the carry trade and treasury yields
Tomorrow is a big day for the stock market that has the potential to set market direction for the next several weeks if not longer.
It begins in the morning with the release of the May Consumer Price Index (CPI). A few hours later, we’ll get the results of the Federal Reserve’s June policy meeting followed by Chairman Jay Powell’s commentary in his live press conference.
Tomorrow will also bring the latest update to the Fed’s Dot Plot. This is a graphical representation reflecting each committee member’s anonymous projection of where they believe rates will be at specific dates in the future. The Fed members update the Dot Plot once every three months.
The March Dot Plot showed a median forecast of three interest rate cuts this year. Given lingering inflation, analysts expect tomorrow’s median reading will show just two rate cuts.
Last Friday’s red hot jobs report is also weighing on hopes for 3+ rate cuts this year
After all, the U.S. economy added 272,000 jobs in May, crushing the expectation for just 180,000 new jobs. This 272,000 reading was also miles above April’s total of 165,000 new jobs.
It’s hard to make a case for a soft economy that needs the support of lower rates in the face of such blistering employment growth.
But our hypergrowth expert Luke Lango isn’t so sure.
To understand why, let’s go to Luke’s Daily Notes from Innovation Investor:
The “jobs report” is determined from two surveys: The establishment survey (“hey businesses, how many people are on your payrolls?”) and the household survey (“hey people, how many of you have jobs?”).
The headline job growth number that is reported all over the media is from the establishment survey. It showed a gain of 272,000 jobs in May.
But the household survey actually showed a loss of 408,000 jobs in May. That’s because the number of people saying they had full-time jobs dropped by 625,000 in May, while the number of people holding part-time jobs rose by 286,000.
Therefore, it is our assessment that the May jobs report was only “strong” because more people are taking on multiple part-time jobs, thereby inflating the establishment job growth numbers. Meanwhile, full-time job holders are in decline and the unemployment rate is rising.
Obviously, that’s not healthy. Obviously, that’s indicative of a weakening labor market – not a super-strong one.
Luke writes that the Fed is well-aware of what’s really happening. And with Wall Street knowing that the Fed is aware, that’s why we didn’t see any wild swings to rate-cut expectations last week.
Luke also pointed toward the rising unemployment rate as a reason why the Fed will proceed with its plans to cut rates
May’s unemployment rate rose to 4%, up from 3.9% in April. This 4% reading is the highest it’s been since January 2022.
For additional context, remember that it was only about one year ago (April of 2023) that the unemployment rate clocked in at 3.4%.
Here’s Luke’s take:
Because of this multi-month swing higher, the unemployment rate has pushed meaningfully above its 12-month moving average. That’s a big warning sign.
Every time since 1970 that the unemployment rate has pushed meaningfully above its 12-month moving average, the labor market was in the early innings of significant deterioration.
The Fed surely recognizes this.
One note on Luke’s reference to an unemployment rate “warning sign”
Former Federal Reserve economist Claudia Sahm gets credit for “The Sahm Rule” – a recession indicator related to the unemployment rate.
It compares the latest three-month average of the unemployment rate with the lowest three-month average over the past year.
When the latest three-month average is 0.5 percentage points higher than the lowest three-month average, the Sahm Rule triggers, suggesting the beginning of a new recession.
Below, we look at a chart of the Sahm Rule Indicator since 1990. The gray bars show recessions. Note how the Sahm Rule line (in blue) begins spiking right at the beginning of each recession.
Today, the Sahm Rule comes in at 0.37%.
We’re still safely below the 0.50% line in the sand, but below, notice the obvious directional trend.
We’re looking at the Sahm Rule Indicator since its low in September of 2021.
Whether this will turn into a spike is unclear, but it’s certainly not a good thing.
We’ll keep an eye on this and will alert you if/when it appears a collision with 0.50% is unavoidable.
Meanwhile, the jobs report spiked the 10-year Treasury yield – but is there a silver lining?
As regular Digest readers know, the 10-year Treasury yield is the single most important number for the global economy and investment markets.
All sorts of interest rates and asset values are directly impacted by whether the 10-year Treasury yield rises or falls.
In the wake of last Friday’s hot employment report, this yield jumped from about 4.28% to 4.45% as I write Tuesday morning.
This isn’t great for stocks.
However, if legendary investor Louis Navellier is right, we’re likely to see a limit to how high this yield will climb thanks to something called “the carry trade.”
To explain how this works, let’s jump to Louis’ issue of Growth Investor last Friday.
After highlighting last week’s interest rate cuts from the Bank of Canada (BOC) and the European Central Bank (ECB), Louis highlighted the implications for Treasury yields since the Fed hasn’t cut rates yet:
Since the Fed will lag European countries in cutting key interest rates, “carry trades” are expected to increase.
Essentially, carry trades are where foreigners put money in the U.S. in search of higher yields and a stronger currency.
If these carry trades approach a trillion dollars or more, they could actually drive Treasury yields lower – and encourage the Fed to cut rates sooner rather than later.
Louis’ believes that the Fed would be encouraged to cut interest rates because it prefers not to fight market rates.
But let’s also connect the dots between a carry trade and domestic earnings
If a wave of foreign capital floods the U.S. financial/investment markets, that strengthens the U.S. dollar thanks to the currency conversion.
Unfortunately, a strong U.S. dollar erodes the profits of multinational firms.
Here’s Louis:
A stronger U.S. dollar pinches profits at multinational companies and boosts the prices of commodities, like oil and gas, for virtually everyone else in the world.
To see how this works, consider someone in, say, France, who buys a U.S.-based product in euros. A stronger dollar means those euros convert into fewer dollars when the U.S. business repatriates its revenues. Fewer dollars of revenue translate into lower earnings – bad for a stock price.
Be careful about assuming this doesn’t affect your portfolio. Between 40% – 50% of the S&P 500’s revenues are generated outside U.S. borders. For the tech sector, that exposure jumps to nearly 60%.
Below, we look at the U.S. Dollar Index. It’s a measure of the value of the U.S. dollar relative to the value of a basket of six major global currencies – the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.
As you can see below, after surging from the beginning of the year through April, it took a breather in May. But it’s clearly back on the move higher today.
So, all eyes on tomorrow
If the CPI data come in cool and Powell sounds dovish, we could see it jumpstart a much-anticipated summer rally.
But if the CPI data are hotter than expected and/or if Powell surprises on the hawkish side, we’re likely in for a selloff as rate-cut hopes continue to wane.
We’ll keep you updated here in the Digest.
Have a good evening,
Jeff Remsburg
