The increase in non-farm payrolls in the United States in August was far below expectations, with the previous value also being significantly revised downward. However, the unemployment rate slightly decreased, hourly wages accelerated, and the labor market released more complex signals. The Federal Reserve's interest rate cut in September is still undecided, with the probability of a 25 basis point cut and a 50 basis point cut currently evenly split.
With increasing uncertainties in the labor market and ongoing inflation slowdown, what consequences will this bring to the U.S. economy and financial markets in the short to medium term?
Michael Hartnett, Chief Investment Strategist at Bank of America, mentioned his five observations in the Flow Show report released this Friday:
<ul>
<li>The probability of a hard landing is generally underestimated. According to the last Bank of America Global Fund Manager Survey, the probability of a hard landing in the U.S. is 13%, while the probability of a soft landing is 76%.</li>
<li>The market is &#34;selling the first rate cut,&#34; with risk assets actively leading the Federal Reserve and no longer focusing on lower growth.</li>
<li>Bullish on 3B bonds, gold bars, market breadth (through defensive stocks): these are &#34;buy on dips&#34; strategies for the second half of the year.</li>
<li>Cyclical homebuilders, banks, and semiconductor companies are most vulnerable to a U.S. &#34;hard landing&#34;; commodities and emerging markets, especially China, are least affected.</li>
<li>In the global market, the real estate and banking sectors in the UK, Canada, Australia, New Zealand, and Sweden have the best opportunities. In all floating rate mortgage markets, the rate transmission mechanism in these sectors affects people's emotions much faster than in the United States.</li>
</ul>
However, Hartnett also acknowledges that while the data still indicates challenges for a soft economic landing, it is not all pessimistic. Specifically:
<ul>
<li>Steepening of the yield curve: usually occurs before or during the start of an economic recession.</li>
<li>The leading indicator inventory-to-sales ratio indicates that the ISM index will remain below 50 for the rest of the year. Defensive stocks are pricing in ISM &lt;50, while bonds and stocks are not pricing it in</li>
</ul>
<blockquote>
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/dffc9b7a-3793-4f12-b410-4805e68cd6c1.jpeg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/dffc9b7a-3793-4f12-b410-4805e68cd6c1.jpeg"/>
The ISM index is correlated with employment numbers over the past 70 years, indicating that the phenomenon of significant job cuts has not yet occurred. This index also explains the reasons for the accelerated softness in labor data (JOLTS, ADP, significant downward revision in July non-farm payroll additions).
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/00e4f83f-2453-4950-9892-2af824913b06.jpeg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/00e4f83f-2453-4950-9892-2af824913b06.jpeg"/>
</blockquote>
Furthermore, in the real estate market, mortgage application purchases remain low, indicating that the interest rate cut has not had a significant boost on the real estate market in the short term.
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/1ff2fae6-8102-4069-ac91-e0e5e1ed0b42.jpeg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/1ff2fae6-8102-4069-ac91-e0e5e1ed0b42.jpeg"/>
In summary, Hartnett believes that although the Fed is likely to only cut rates by 25 basis points at the first rate cut, it will still cut rates significantly afterwards. He believes that the most favorable strategy now is to &#34;sell the first rate cut&#34; and wait for a better timing to enter the market with risk assets.
The reasons are as follows:
<blockquote>
<ul>
<li>Reversal of fiscal stimulus: US government spending has decreased by 6% year-on-year over the past 12 months.</li>
</ul>
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/a0ec9624-9bec-4fa2-a905-3fe6e596161f.jpeg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/a0ec9624-9bec-4fa2-a905-3fe6e596161f.jpeg"/>
<ul>
<li>The current real basic interest rate in the US is 6.5%, the highest level this century, especially unfavorable for the US small business sector.</li>
</ul>
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/bb2c00c4-6ae5-4e8b-9349-e978821df8ca.jpeg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/bb2c00c4-6ae5-4e8b-9349-e978821df8ca.jpeg"/>
</blockquote>
One last point: Hartnett would be even more pessimistic if employment numbers were lower than they are now.
Before the non-farm payroll report was released on Friday, Hartnett predicted:
<blockquote>
If the non-farm payroll additions in August are less than 100,000 and the unemployment rate is above 4.4%, indicating a &#34;hard landing&#34; for the US economy, then the Fed will cut rates by 50 basis points in September, and the forecast for the 10-year US Treasury yield will approach 3%.
The perfect data would be non-farm payroll additions between 150,000 and 175,000, with average hourly earnings increasing by less than 0.1% month-on-month, indicating a &#34;soft landing&#34; for the US economy, with technology and energy stocks leading the market turnaround.
</blockquote>
The actual situation was an increase of 142,000 in employment numbers, a 0.1 percentage point decrease in the unemployment rate, and an accelerated increase in average hourly earnings compared to the previous month. Although the situation was not as bad as Hartnett predicted, it was enough to impact the stock market as expectations for a 50 basis point rate cut by the Fed quickly diminished

Hartnett believes that the probability of a "hard landing" in the United States is widely underestimated. Even if the Federal Reserve only cuts interest rates by 25 basis points for the first time, he expects a significant further rate cut afterwards. He believes that the most favorable strategy now is to "sell on the first rate cut" and wait for a better timing to enter the market with risk assets

- The August US non-farm payroll data fell far below expectations, with a significant downward revision of the previous figures. Despite a slight decrease in the unemployment rate and accelerated hourly wages, the labor market signals complexity, leaving the Fed's September rate cut decision uncertain between 25 and 50 basis points.
- Uncertainties in the labor market, coupled with ongoing inflation slowdown, raise concerns about the future consequences for the US economy and financial markets. Chief Investment Strategist Michael Hartnett highlights five observations in his recent report, emphasizing probabilities of a hard landing, market reactions to rate cuts, and sector vulnerabilities to a US economic slowdown.
- While the data suggests challenges for a soft economic landing, indicators like steepening yield curves and inventory-sales ratios point to potential economic downturns. Hartnett advises caution, suggesting a sell-off before the first rate cut and anticipating further substantial rate reductions post the initial cut, influenced by factors like fiscal stimulus and high real interest rates in the US.

Bank of America's Hartnett: "Fed's first rate cut", sell!