Announcement: Barring a major market event, the next Three Pointer will be released on August 18. 

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Friday Matinee

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Soundbite: The questions about the Fed falling behind the curve were front and center this past Friday after the weak payroll data. However, the Fed quietly removed a key phrase in Wednesday’s FOMC statement that spoke volumes: despite recent tariff deals, uncertainty had not diminished. We are focused on a detail within the PCE inflation report and the employment-population ratio, because those two metrics will define the growth/inflation tradeoff going forward for the Fed.

Look beyond this cinema: The trailer on Thursday created a negative mood in the theater when Trump ratcheted up tariffs, then Friday’s main feature was a thriller with an avalanche of downward revisions, followed by a comedy when the president fired the head of the BLS. The post-credit clip included Fed Governor Kugler resigning before her term ends next year. We are hoping for a major star to step on the set of the FOMC, but if we get a B-actor, then the sequel could turn into a horror movie.

At Wednesday’s press conference, despite concerning comments from Powell around the subject of raising rates if inflation rises, he did stick to the basic script that tariffs should be a one-time effect and on six separate occasions discussed the downside risks to employment.

The key element that really caught our attention was a change in the Fed statement that has not received the attention it deserved:

June statement:

“Uncertainty about the economic outlook has diminished but remains elevated.”

July statement:

“Uncertainty about the economic outlook remains elevated.”

Jerome Powell repeated that uncertainty is around the same level as it was at the June meeting, so despite tariff deals being struck, there is no improvement in the visibility the Fed requires to cut rates.

Their concern about uncertainty still being problematic and keeping them from cutting rates played out just one day later when the president raised tariffs. However, we have singled out the Dallas Fed PCE decomposition and the employment-population ratio as our two beacons to clarify future Fed actions. The latest Personal Consumption Expenditure Price Index shows that 30% of the inflation index is rising by more than 5%, and until that level drops, a majority of voters will push back against a rate cut.

Our second beacon, the employment-population ratio, is the percentage of adults who continue to hold jobs. This ratio has been gradually declining, but just hit its lowest level since December 2021 when it was released in the nonfarm payroll report. Friday, Governor Bowman outlined the reasons behind her dissent, and she highlighted the decline in that ratio as one of the major reasons to cut rates to preemptively hedge against damage to the labor market.

We are comfortable that monitoring those two specific datapoints, while not normally the central focus of investors, will be given significant consideration in the Feds three remaining meetings this year, starting with September. As the relationship between these two unfolds, the markets should move correspondingly.

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Unemployment’s New Math

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Soundbite: In markets, we have found that when things get chaotic, it is best to keep things simple. That certainly applies to the recent employment data. The payroll numbers are being distorted by seasonal adjustments in education employment, so we recommend ignoring that data in favor of the household survey’s unemployment rate and employment-population ratio, but to do so involves understanding the landscape has changed. Immigration policy’s impact on the labor supply is the new swing factor.

The employment report has been a whipsaw lately: it was revised higher in June before the big downward revisions in July. A major part of the massive drop in May and June was centered on state and local payroll revisions, and the July data still shows a high increase in June for education payrolls. That means the August data is also subject to more revisions, and analysts know that the major benchmark revisions are still pending, making each headline number to come questionable. Therefore, the market will shift its focus away from this series, and Chair Powell even said during the press conference that the unemployment rate is “the only thing that matters.” However, it is important to recognize how the ground has shifted when analyzing that rate.

We normally do not associate weak employment growth with a stable job market. Lower employment traditionally leads to lower wages and lower consumption. However, this is not always the case in a shrinking labor force world. That is why we were not surprised by the continued strong income data despite other weakness in Friday’s data. The average paycheck (hourly earnings multiplied by hours worked) in the employment report retained its robust trend, rising at a 5% annual rate in July.

With immigration policy shrinking the supply of labor, depressed hiring demand from tariff uncertainty paradoxically does not necessarily result in a weak jobs market. If incomes stay high, there is no need for rate cuts, unless, of course, the labor participation rate and the employment-population ratio start to decline more aggressively. That would mean the demand for labor would be contracting even faster than supply.

For now, the unemployment rate is hanging on by its fingernails: the rate came in at 4.245% Friday, so it just escaped ticking up to 4.3%. There will also be increased emphasis on other data, such as initial claims for unemployment insurance. That series is best measured with a 4-week moving average, which has contracted by a significant 10% since the June FOMC meeting. That steady decline has comforted the Committee along with the fact that a smaller labor pool will help cap rises in the unemployment rate.

Watch the weekly claims data closely (it comes out every Thursday) and the market’s reaction to it, as well as the monthly unemployment rate. The next payroll report out in September should be one of the most anticipated economic releases into year-end, but cut through the noise and focus on the unemployment rate and, from our first point, the associated employment-population ratio.

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Complacency Reigned Supreme…Until Friday

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Soundbite: We had warned that Pave’s volatility risk factor betas had plummeted to levels not seen in years. Additionally, Goldman Sachs reported the global risk premium on Investment Grade bonds fell to their lowest level since July 2007. This could cascade into another problem because the Magnificent Seven have become more reliant on issuing debt for financing the data center building frenzy – if there are any bond market dislocations, their lenders could fall into financial trouble and create a liquidity event.

There is an uncomfortable combination of extreme risk-seeking behavior and overweight positioning currently. JP Morgan’s stock squeeze gauge just spiked to its highest level since the 2021 GameStop/Wall Street Bets circus. Nomura is reporting that volatility-controlled funds and systematic trend followers have accumulated longs at the 99th percentile over the past month and the 100th percentile over the last quarter.

This is the textbook case of “there is no one left to buy.”

Friday’s 6210 low in the S&P 500 is critical because of its proximity to the lower Bollinger Band that many investors follow. Assuming that support level holds (even if there is a break below it this week that reverses back above), it can result in a quick reversal. That does not mean new all-time highs will follow, however. The massive up/down gyrations recently often mark turns in the market.

One-sided long positioning argues for limited upside as we approach the seasonally negative September and October period. The double digit VIX rise on Friday fits the bottoming dynamic in seasonal volatility we wrote about last week.

Watch cryptos and especially follow Ethereum, which has been the focus of recent speculative flows. Use $3400 as a sentiment barometer—below could signal more risk off, and if it keeps a bid above that price, it is a signal of optimism that could help the major equity indices bounce.

However, we recommend keeping the urge to buy the dip in check unless you trade in the shortest of timeframes.

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What to Look for This Week

(All times E.S.T.)

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1. Thursday, August 7 at 8:30 a.m. Initial Claims and Continuing Claims. Given the dizzying revisions both up then down in the last two nonfarm payroll reports, everyone will be looking to see if the six weeks of improving claims data can extend its streak, which is pointing to a much healthier labor market than July’s payroll data. Continuing Claims are still hovering near their highs, as evidenced by the unemployment rate for those out of work more than 15 weeks.

2. Tuesday, August 5 at 10:00 a.m. July ISM Non-Manufacturing PMI, where investors will scrutinize the employment subcomponent as the importance for a clear employment picture has intensified.

3. Tuesday, August 5 at 8:30 a.m. Balance of Trade for June. The past two reports showed a sharp drop in imports after the front loading earlier this year. Exports dropped significantly in May after a spike in April, so we will be looking at changes in both legs as well as the overall Trade Balance which widened in May.

FOMC Voters Speaking: The most important speech could come after the market goes home for the week when one of the dissenters, Governor Bowman, speaks Saturday, August 9 at 12:15. On Wednesday, August 6 at 2:00 p.m., Boston Fed President Collins and Fed Governor Cook speak on a panel. St. Louis Fed President Musalem speaks Friday, August 8 at 10:20 a.m. and he has been concerned about interest rate expectations becoming unbalanced.

Earnings Season: Monday, August 4, high-flyer Palantir reports after market close. Caterpillar could lend insight into capex equipment spending and Duke Energy could discuss data center electricity demand on Tuesday, August 8, both before market open, and semiconductor manufacturer AMD reports after market close.

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