Quick Thoughts on Bear Steepening
Before we move to the July employment situation report, here are our thoughts on the bear steepening of the Treasury curve led by real rates. The 2s10s real rate (TIPS) curve bottomed at -154bp on July 24, it has steepened to a still deeply inverted -129bp. The move is not yet large enough to trigger a risk-off episode, but another 25bp could be a necessary, if not sufficient, condition for a cross asset class correction. The origin is the loosening of the Bank of Japan’s yield curve control as well as the Treasury’s plan to increase coupon issuance. The timing is ominous, we had real rate shocks in August 2018 and 2019, the lows for the year for 10-year real rates in 2020 and 2021 occurred in August as well and there was a sharp move higher beginning in late July 2022. Given our view that after 5 decades of energy deficits and a negative correlation with the price of oil, the dollar is now a petrocurrency. Crude above $80, combined with moribund global export activity, could trigger sharp declines in Japan, China, South Korea, Germany and UK exchange rates, like September of last year. In other words, just as the domestic data convinces the Fed to end the hiking cycle, something else might break. Index implied volatility isn’t cheap relative to realized volatility, but it’s worth a look if the bear steepening of the real rate curve continues.
Labor Demand Cooling
In the FOMC press conference, Chairman Powell noted surveys, quits, openings and payrolls as evidence labor demand is cooling. On Friday the 2Q employment cost index (ECI) cooled from 1.2% to 1.0%. This morning July ISM manufacturing employment fell to 44.4 from 48.1, the June private sector quits rate and job openings slipped to post-lockdown lows of 2.7% of 9.582 million respectively. Hours worked from the regional Federal Reserve manufacturing and service sector surveys improved modestly in July but remain below the boom/bust line hinting the BLS July work week may slip back to last cycle’s low.
It appears demand was considerably weaker in 2022 than the BLS estimated. We’ve been convinced the birth/death adjustment was overstating job creation, and thanks to Mike Green for drawing to our attention the morning of the FOMC meeting, the BLS released the quarterly Business Employment Dynamics (BED) that revised the birth/death net adjustment from 1.34 million jobs in 2022 to basically no jobs. Chairman Powell didn’t site this, perhaps because he didn’t want to explain it and have to defend a model many of us have been suspicious of for some time. We suspect by the time we get to the annual benchmark revision history is going to look decidedly different. The BED runs through 4Q22, for ‘23 the birth/death adjustment has added 63,000 jobs, given the slide in the NFIB Small Business Survey and 1 million drop in job openings for businesses with 1-49 employees it seems probable that the underlying trend is softer small business employment. While demand appears to be cooling, there is no evidence in recent data that layoffs are accelerating. Jobless claims moved sharply lower in July and the layoff rate in the June JOLTS report slipped back towards the low. Additionally, the July Conference Board labor survey respondents characterizing jobs as hard to get slipped to 9.7%, a tenth above the all-time low in March ‘22 and jobs plentiful responses increased to 46.9% from 45.4%. On balance the data since the June employment situation report is mixed but we continue to be concerned about a deterioration in the opaque small business sector. The Senior Loan Officer Survey only added to these concerns due to tighter lending standards and weaker demand.