Investment Strategy View: Warning Signs

Too Cold For Comfort?

The U.S. economy has been the envy of the world for a long time, often called the locomotive of the global economy. That has especially been the case over the last few years: The U.S. emerged from lockdowns faster than most other developed economies, for example. And when central banks across the globe embarked on a hiking cycle to fight high inflation that was followed by corresponding economic weakness, the U.S. continued chugging along. However, the chickens might be coming home to roost after all and the U.S. economic strength could begin to weaken, as some data suggest the lagged effects of tight monetary policy are now starting to kick in.

In the first quarter, GDP grew at a seasonally adjusted annual rate of 1.3%, the slowest pace since the second quarter of 2022. What’s more is that after initially tracking toward an above-trend level of growth, the Atlanta Fed’s GDPNow model that tracks second quarter GDP growth has turned lower too, now sitting at 1.8%.

On their own, 1.3% or 1.8% aren’t necessarily bad growth numbers for a mature economy like that of the U.S., but the deceleration is still notable. Any further deceleration would take the economy from a slight slowdown to a significant one, and potentially even into recession territory.

Cold Side of the Labor Pillow

It would be easier to explain away concerns if GDP growth were the only indicator sending warning signs, but the labor market — a key pillar of economic strength — is also signaling weakness. That may sound off-base considering the nonfarm payrolls (NFP) report has been averaging over 240k jobs added per month of late, but a closer look is still warranted.

To start off, while the recent average of jobs added has been pretty high, the last monthly jobs report showed only 175k jobs added, the lowest number since autumn. Beyond that, however, other more comprehensive labor data paints a different picture. The Quarterly Census of Employment and Wages (QCEW) is released about five months after quarter-end and incorporates a more precise picture of trends in employment, wages, and business formation.

Theoretically, these data are supposed to measure more or less the same thing, but QCEW shows 690k fewer jobs added than the monthly jobs report. This could shake things up dramatically if it continues, because annual revisions for the jobs report draw on what the QCEW says. In other words, are massive revisions coming? The period between April 2022 to March 2023 is already mostly locked in, but beyond that, data is likely to change. Said another way, the monthly jobs report could be overstating the strength in the labor market.

Dual Mandate Tensions

Inflation has occupied most of Fed officials’ attention over the last several years, and while they’ve noted that risks to their dual mandate of price stability and maximum employment have gotten more balanced of late, the risks may ever so slightly be starting to tilt in the direction of the latter. A big part of why the Federal Reserve has pushed back on rate cut expectations is that the economy and labor market have seemed strong. But it will be tough to keep doing that if the data shifts meaningfully.

Investors have adjusted to the Fed’s view and lowered their expectations for rate cuts, currently expecting four or five of them over the next 18 months. But given we will get a sneak peak at jobs revisions in August — a few days before central bankers get together in Jackson Hole no less — rate cut expectations could be set for a summer repricing.

Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Mario Ismailanji is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. His ADV 2B is available at www.sofi.com/legal/adv.