Big shout out to all the borrowers that rate locked two weeks ago and caused rates to plunge. This reminds me of the well-known Rate Lock Rule, which states, “whatever you decide to do about a Rate Lock, rates will move the opposite direction the next day.”
You’ll be hearing a lot in the coming weeks about the Sahm Rule, which is named after a former Fed economist, Dr. Claudia Sahm. We spent a lot of time talking about it this time last year because it was very nearly triggered as unemployment started climbing.
I’m so jealous she has a rule named after her. Since the only things named after me seem to be hurtful, like “The Inverse JP” or “Ultra Opposite Conklin ETF” or the oddly specific, “That Guy Didn’t Think the Fed Would Be Hiking in ‘22 So Don’t Listen to Him Rule”, I am going to give myself a cool one.
The JP Rule.
The JP Rule states, “On a long enough timeline, I am always right.”
It’s just that sometimes, it’s a really really really really long timeline…
If you’re wondering, “Isn’t that kind of like giving yourself a nickname?”, then you haven’t been paying attention to how little shame I have.
Me introducing myself at a conference: “Hi, I’m JP but most people call me Mr. Clutch because I’ve got ice water in my veins.”
Sarah: “No one calls him that.”
JP: “Showtime’s the name, rate prediction’s the game.”
Sarah: “Hard to believe you were single when I met you.”
JP: “Sometimes they just call me Comaneci because I’m a perfect 10.”
Sarah: “More like the Inverse Comaneci…”.
Ahh, the Real Boss - she keeps me grounded. But now that I’ve joined the exclusive club of people with economic rules named after them, I assume we are all on a first name basis with each other. I wonder how Claudia views her own rule?
Claudia: "The Sahm rule is an empirical regularity. It’s not a proposition; it’s not a law of nature."
Well, this is where we differ, Claudia. The JP Rule is, in fact, a law of nature. As immutable as gravity and Philadelphia sports disappointment.
Unlike me, Dr. Sahm is legit. But like me, she’s alive (so at least I have that much in common with her). This isn’t some economist that worked 100 years ago. She posts online and does interviews all the time. Go follow her.
This Week
- 10T: 3.80%
- German Bund: 2.17%
- 2T: 3.88%
- SOFR 5.35%
- Term SOFR 5.35%
- Bank of England cuts interest rates to 5.00%
- JOLTs Job Openings 8.184M vs. 8M expected
- ISM Manufacturing PMI 46.8 vs. 48.8 expected
- Non-Farm Payrolls 114k vs. 175k expected
- Unemployment Rate 4.3% vs. 4.1% expected
The Fed Talked About Cutting Last Week
Well, well, well, how quickly the tides have turned. All of a sudden, the entire universe is on the rate cutting bandwagon.
Is anyone else surprised by how quickly everyone threw in the towel? One report? That’s all it took? One bad number and you abandon your higher-for-longer soapbox?
JPM and Citi are both now calling for not one, but two, 50bps cuts by year end. That’s 4.33%. By 12/31.
I don’t think 50bps is on the table right now. That’s a panic move, like when they had to hike 75bps. It’s an acknowledgement that they are behind the curve.
As much as I want to bask in the win, I actually think the current sentiment is likely overdone. Not because the Fed shouldn’t be cutting this much, but because they won’t. I think they’re likely to be slow to pivot and a looming election makes it tough to justify significant cuts. I wouldn’t be surprised to see a pattern like we saw with the hikes where they start with 25bps and then eventually move to bigger moves.
Then again, we’ve seen the Fed shift sentiment violently from one meeting to the next, so I guess it’s not off the table.
There was a point on Friday where the odds of 50bps in September exceeded the odds of 25bps. That has corrected, but it highlights how volatile Friday was.
The odds of just 50bps of cuts by year end are just 3%. Alternatively, there’s a 30% chance of FF < 4.5%.
This time next year? There’s a 70% chance of FF < 3.5%. Surely the Fed saw this coming, right?
June 25th – Fed governor Michelle Bowman said that she’s expecting no rate cuts this year
Heck, it wasn’t that long ago that Fed officials were talking about some possibility of more hikes.
April 11th – The Fed might not be done raising interest rates just yet.
It’s not just the Fed that’s behind the curve, so are our competitors 🙂.
July 29th – September Rate Cut in the Bag? Not So Fast.
July 8th – Fed rate cuts unlikely as market fails to provide strong indicators.
They went Inverse JP and it backfired. If imitation is the sincerest form of flattery, what does doing the opposite suggest?
It’s not just me and Sahm with cool rules named after ourselves. Other economists have rules named after them as well, such as the Taylor Rule. Named after John Taylor, this has been an influential guidepost for the appropriate Fed Funds level. After the report on Friday, Taylor was interviewed and said his rule suggests Fed Funds should be at 4% right now.
Does our newsletter two weeks ago, “Fed Funds Should Be At 4%” seem so outlandish now?
Like Philly fandom, the JP Rule also comes with a healthy dose of unjustified arrogance.
Strongest Labor Market in the History of the Universe
Wanna hear something funny? Friday’s NFP wasn’t even the weakest print this year. April’s was 108k. Don’t remember that one? That’s because the initial release claimed gains of 175k. It wasn’t until the next month’s report that it was revised down to 108k, but we were distracted by the whopping 272k jobs gained that month…until it was revised lower by 56k a month later…
I’ve been saying the unemployment rate is more important than the NFP print for a few months now. The Unlike most economic rules, the Sahm Rule is beautifully clear and depends exclusively on the unemployment rate.
The Sahm Rule JP Dumbed Down Version – if unemployment climbs swiftly, we are in the early stages of a recession
The Sahm Rule Precise Definition – if the three-month moving average of the unemployment rate exceeds its 12 month low by at least 0.5%, we are in a recession
Don’t skip that last part – we are already in a recession. We have spent a year proving labor data has a huge lag, so this rule makes sense. The unemployment rate is up nearly 1% in a year, suggesting it’s already too late to avoid a recession.
Sahm confirmed on Friday that her rule has been triggered, but she also has repeatedly cautioned that this time might be different. Maybe it will be. Or maybe it’s just a mild recession. Or maybe it’s the start of the wheels falling off. Who knows.
But just six weeks ago, the Fed’s forecasted year end unemployment was 4.0%. I obviously don’t have issues with being wrong, but I do have issue with being lazy.
That forecast was stale before they made it. Here are two real time indicators of labor health that suggest the official stats will continue to cool rather than level off. The Fed’s reliance on data is admirable, but if the data is stale does it defeat the purpose?
ZipRecruiter’s monthly survey is showing a pretty rapid deterioration in labor market conditions. The solid black line is job seeker confidence.
Indeed’s Job Posting Index is down 12% y/y.
For the Nerds in the Back
This section on unemployment is pretty cool, but I understand if you’d rather skip ahead to the rates section click here.
In last week’s newsletter, I scrapped an entire section I had written about the jobs report. The newsletter was already too long and I figured I would just use it this week. Now this week’s is already too long but I don’t want to ditch it.
As with countless previous newsletters, my conclusion was the same: “The job market is not as strong as the headline stats suggest.”
Friday may have confirmed it. But let’s examine how the unemployment rate leads to monetary policy mistakes in the early stages of a downturn.
Two weeks ago, the Minneapolis Fed research published a research piece, “Quits, Layoffs, and Labor Supply.” It is dense. Or rather, I am, which makes it hard for me to translate. But it’s incredibly important for how we view unemployment.
Key takeaway – during economic slowdowns, the unemployment rate is artificially stable at first.
Rising unemployment is people departing the workforce. A “departure” can further be divided into voluntary/involuntary. These get reported as “quits” and “layoffs”.
Quits + Layoffs = Increase in Unemployment Rate
Times are good
Quits (red) – goes up because you feel good about job options
Layoffs (blue) – goes down because companies aren’t laying off people
Times are bad
Quits – goes down as you get nervous about job prospects
Layoffs – goes up as companies lay off people
As the economy slows, fewer people quit. This helps offset the new increase of layoffs, which then keeps the unemployment rate down for longer. Artificially stable. Which is exactly what the graph below of total separations (regardless of reason) illustrates.
Let’s say total departures are 100k one month. During good times, 80k might be quits and 20k might be layoffs. Stable, but still strong.
But what if we flip those? If 80k of the 100k separations are layoffs, that’s totally different, right?
It’s the composition of the separations that matters.
The signal isn’t just climbing unemployment. By then it’s too late. Fewer quits have been holding down the unemployment rate, concealing the underlying weakness.
“This finding suggests that looking at the unemployment rate alone might not give a complete picture of labor market weakness. A more comprehensive view would consider the changing composition of separations (more layoffs, fewer quits) even if the total separation rate remains relatively stable.”
Guess where you find the breakdown between quits and layoffs?
The friggin’ JOLTS report because…of course.
The graph below from the BEA shows the composition of the separations.
Gold – quits (steadily falling recently as the economy has cooled)
Red – layoffs (holding steady at 1.0%)
“So quits are falling, seemingly confirming a slowing labor market. But layoffs are holding steady? I thought you said that rising layoffs would be the signal?”
It is, but the authors also note that the BEA’s survey is likely understating layoffs:
“This means that classifying flows from employment to non-participation as quits understates the level of lay-offs by 40%, which will be especially important considering business cycle fluctuations.”
And don’t forget, the JOLTS survey is suffering from a terrible response rate, down from 70% to 30%. That’s a big reason we see such material downward revisions each month.
Last, but not least, it’s stale. It was last updated following the May report.
It sounds noble to be data dependent.
But if that data is stale, doesn’t it kind of defeat the purpose?
Fixed Rates
Before you ask, I don’t have the first clue where Treasury yields are headed. But I feel pretty good they aren’t headed to 8% like Jamie Dimon cautioned.
Or 5.5% like Jim Bianco suggested repeatedly throughout the first half of the year.1, 2
We started last week with the T10 at 4.19% and finished at 3.79%. That’s 0.40% in a week. Sheesh.
We broke 4.12%, 4.03% and even 3.81% resistance levels in one week.
It’s not uncommon after a huge swing for rates to rebound. If you had bought $100mm of newly issued T10’s two weeks ago with a coupon of 4.25%, you’ve made about $3.5mm in profit. That’s more than a 90% annualized return. You sell, which causes rates to climb a little. If lots of people sell, the move is more significant. I think a lot of traders will take some chips off the table.
My guess is 3.81% ends up being the new floor, rather than the new ceiling. The high end will be around 4%, and, with a quiet data week, I wouldn’t be surprised to see T10 yields gravitate towards the middle of the range – around 3.90%.
If we break lower, the T10 doesn't have a lot of resistance until 3.35% (you may recall how that held up for like 10 years until this cycle).
Whether you’re worried about rates spiking again for a rate lock or market panic gaining momentum driving rates lower and impacting a prepay, you can hedge it. Just give us a call.
The Week Ahead
I texted JMo on Friday after the report.
JP: “Hi.”
JMo:
The silence is deafening.
The JMo Rule states, “When I am right, I chirp a lot. When I am wrong, see the JP Rule and call me back in a few years.”
