Bad News is Good News

There’s a plethora of economic news today. The general theme is the economy is gradually slowing and inflation is continuing its downward trend, which means the Fed has more reasons to pause its interest rate hikes sooner.  That’s driving up risk assets up and interest rates down.  Here is my quick take:

Wage Growth is Decelerating Faster than Expected

The single most important data point today is probably the lower-than-expected growth in wages.  At 4.6% y/y, December wage growth came in significantly lower than the 5.0% Street consensus. The Fed has specifically pointed to this metric as a concern that inflation may be more persistent and, therefore, a key reason behind their expectation for no rate cuts this year. This data point directly contradicts this view and the Fed Funds futures have reacted and are now predicting just a 25bps rate hike next meeting and almost three 25bps rate cuts during the next 12 months.

For the markets, this is a good print.  Lower interest rates means higher stock and bond prices.

Payroll Growth is Decelerating Faster than Expected

Also notable is the slowing in payroll additions.  In December, the economy added 223,000 jobs, which is down sequentially from November (which was also revised downward).  Although this print beat the consensus expectation of 203,000, directionally, the labor market is cooling and that is another important sign the Fed is looking for.

As we have called out before, Temporary Help jobs have historically been a predictor of the health of the labor market.  In December, 35,000 temporary jobs were lost.  This is the fourth consecutive month of temporary job losses.  This is clearly not a good sign. The aggregate number employed is near record highs, so the sky isn’t falling but the trend is clearly down.

ISM Services PMI is now Contracting

The biggest surprise of the morning was the ISM Services PMI print of 49.6.  This print came in much lower than the Street expectation of 55.0 and represents a huge sequential decline from November. Furthermore, under 50 means the Services part of the economy is now contracting.  Digging into the report, there were six industries that reported negative growth in December: Real Estate, Rental & Leasing, Wholesale Trade and Other Services.  None of this surprises us. We have discussed before that the housing market has come to a screeching halt due to lack of affordability and the Wholesale Trade is really part of our “Goods Recession” thesis.  Retail inventories are too high and consumer demand has declined dramatically for “Pandemic” goods. (The fact that Wholesale Trade is captured in the Services PMI and not the Manufacturing PMI is inconvenient and will muddy the Service data in the coming months.)

The bottom line is these new macro datapoints reveal broader economic softening and a continuing downward trend in inflation.  This bodes well for the Fed pausing rate hikes sooner and should continue to support a stabilization in interest rates, particularly the further out the curve you go.  This supports our bullish view on high quality bonds.

This data does not paint a good picture for particular industries, which supports our “Goods Recession” thesis.  Avoiding these potholes is paramount.  The data suggests that a defensive posture is still necessary.  We are still in capital preservation mode.  The equity market could still decline further.  However, one emerging bright spot is that Growth names, particularly those that have been really beaten up over the last year, may start getting a bid as interest rates stabilize or even decline.  This is an interesting development to monitor.

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