The employment figures are misleading, the coming banking crisis and why inflation will weaken

For most of last week (ending April 5), financial markets were worried about the upcoming jobs report, and when markets worry, indices weaken. But after Friday morning's “strong” (superficially) jobs report, these markets breathed a sigh of relief and recouped much of the week's losses. Still, the week ended with lower prices in both stock and bond markets. For the week: Nasdaq: -0.8%, S&P 500: -1.0% and Dow Jones Industrials: -2.3%. Perhaps the market is recognizing the problems in the manufacturing sector that we have been highlighting for several months; hence the significant underperformance of the Dow Jones Industrials.

The employment dilemma

The chart below shows that prior to March 2022, the Non-Farm Payrolls (NFP) and the Quarterly Census of Employment and Wages (QCEWCEW) matched each other. Then they diverged, and the cumulative difference is that NFP emerges with five million more jobs. We find it strange that BLS revised down its original figure 11 months into 2023. According to the QCEW report, average monthly wage growth in the 11 months to December last year was +130,000, not the +230,000 claimed in the NFP reports. In fact, this has been confirmed by economists at the Philadelphia Federal Reserve (see here).

Non-farm payrolls compared to QCEW estimates

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And let's not forget the manufactured numbers in the NFP reports from the Birth/Death (B/D) model, a number that is usually somewhere in the neighborhood of +100,000 and is added to the NFP to account for long-term small business growth to compensate for the fact that no survey is carried out to determine the NFP numbers. According to Rosenberg Research, the B/D “add-on” created nearly half (1.36 million) of NFP jobs (2.75 million) in the year ended February. Rosenberg also states that new business “births” fell by -4.4% in the year ended February, while business “deaths” increased by +24.1%. Therefore, even the QCEW's lower estimate for job growth of +130,000 per month seems suspect.

In previous blogs we have commented on the large discrepancies between NFP and sister Household Survey (HS) data, which has so far shown negative job growth in 2024. A closer look at the QCEW data shows that this is the case for the year ending 2024. In February, full-time jobs fell (-284,000) while part-time jobs increased (+921,000). According to Rosenberg Research, the full-time/part-time question is even worse than QCEW suggests. They indicate a loss of 1.3 million full-time jobs last year! Whatever is true, negative numbers are not good here!

Job changes: Since February 2023 (in thousands)

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Furthermore, while BLS counts full-time and part-time jobs as equivalent, logic tells us otherwise. Despite the NFP headlines, the fact that full-time jobs are disappearing points to a weakening economy.

More on the upcoming CRE/banking crisis

In our last few blogs we discussed the looming crisis in commercial real estate loans. As mentioned last week:

Delinquencies on leveraged loans now exceed 6% (normal is <3%). This level is approaching the level of the 2001, 2008 and 20 recessions. According to Moody's, office vacancies are at record levels. Commercial real estate (CRE) prices are in free fall. According to Rosenberg Research, 29% of all commercial properties and 56% of office loans now have negative equity. Shopping centers are struggling and apartment buildings are overbuilt (falling rents).

The pace of commercial property foreclosures began with some cases in the fourth quarter. First, there were some large commercial property foreclosures in San Francisco. But the pace increased rapidly in the first quarter, and now as we enter the second quarter, it appears that significant commercial property foreclosures are occurring almost daily. The subheading of this section, ie Coming CRE/banking crisisis relevant for two reasons: First, as the chart shows, banks hold half of CRE debt.

Banks hold half of the outstanding CRE debt

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Therefore, we expect loan loss provisions (which are deducted from bank income and possibly capital) to increase rapidly over the quarter and year. As was the case with New York Community BankNYCB (NYCB) in the fourth quarter of last year, one or two large loan defaults can have an outsized impact on a bank's financial position. Since this Q4 report, NYCB has successfully raised additional capital with the help of former Treasury Secretary Mnuchin. However, as commercial real estate foreclosures increase, as they appear to be doing, opportunities to raise capital will dwindle.

As in every banking crisis this century, the Fed will most likely open a special “lending facility” to which banks can make commitments if it appears that there will be unrest in the financial markets or that there will be significant bank drawdowns. who are experiencing large losses in commercial real estate They provide collateral (perhaps even the distressed companies) and get the liquidity they need at special rates and conditions, just as they did in March 2023 when Silicon Valley Bank and Signature Bank failed.

Nevertheless, as the economic crisis spreads, a recession is inevitable.

Inflation and the Fed

All Fed speakers lately have emphasized that they need to see further progress on inflation before they are ready to begin cutting rates. As a result, interest rates have increased.

Yield on 10-year government bonds

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Note in the chart that the 10-year Treasury yield rose from an interim low of 3.79% on December 26th to 4.38% at the close on Friday (April 5th). The next release of the Consumer Price Index (CPI) will be on Wednesday, April 10th. If this report turns out to be “hotter” than expected, as was the case in January and February, interest rates could rise further and, undoubtedly, stocks would likely falter. However, we do not believe this will happen as the cost of accommodation, which accounts for more than 35% of the CPI index, is lagged in the CPI calculation (so we already know how it will be affected).

Year-on-year change in national rental index (2019 – present)

Apartment list

Rent increases declined rapidly in early 2023 and have been negative since last May (according to the National Rent Index chart shown above). Since the CPI calculation method uses lagged rental data, the high rent increases in 2022 had a significant impact on the year-over-year calculation (the one that the Fed seems to be fixated on). Note, however, that these rents fell rapidly in the spring of 2023 and became negative in the June to December period. If anything, rents weighing over 35% in the index will have a neutral to negative impact on CPI well into 2025. This is the main reason why we are not worried about a rise in CPI inflation. Still, the Fed seems concerned, and that's what matters when it comes to markets.

One positive (cautious) note from Fed Chairman Powell is that in his last public appearance, he reiterated his post-press conference comment that the Fed would “cut” interest rates this year. Given that full-time jobs are shrinking, existing home sales have been weak (high mortgage rates!), industrial production has been flat or declining, and real retail sales have been flat, we think the Fed would be better off cutting rates sooner rather than later. Still, the market chances of a rate cut at the May meeting are microscopically small, and in June they currently stand at just 50.8%, roughly equal probability (see chart).

Target interest rate probabilities for the Fed meeting on June 12, 2024

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Final thoughts

The employment numbers, while strong on the surface, appear to have a very weak underbelly. Full-time jobs are disappearing, and since mid-2022 the divergence between the main NFP number (which is the only number discussed in the media) and the quarterly employment and wage count that used to accurately track the NFP has been staggering. The fact that almost all initial revisions of the NFP since the beginning of 2023 have been negative could lead to questioning the reliability of the current NFP methodology. And as you can imagine, there are some who scream “manipulation.”

Given the rapidly growing CRE problems and the fact that banks hold half of all CRE loans, the banking system could well be facing another crisis. The share of losses from non-performing loans will certainly increase significantly over the course of the year. Therefore, we expect that there will be “capital problems” in the banking system, and we expect the Fed to “save the day” again in such a scenario, as it has done throughout the century.

While the Fed has now convinced financial markets that interest rates will remain “higher for longer,” resulting in rates retracing half of their Q4/23 decline, Powell is also playing the “pigeon” and publicly saying several times, that the Fed “will be this.” Cutting interest rates in 2024.” However, market odds of a rate cut in June had fallen to 51% on Friday (April 5). On Thursday they were at 59%, so the “strong” NFP number took more wind out of the sails of the “June Rate Cut”.

However, we believe that given the CRE issues and their impending impact on banks, as well as the positive impact that falling rents will soon have on CPI inflation, an earlier and faster rate cut would be the optimal policy. Unfortunately, we have no influence on the FOMC.

(Joshua Barone and Eugene Hoover contributed to this blog.)