Understanding the Jobs Report and Its Implications for a Recession

Impact of the Jobs Report on Treasury Yields

Eric Hickman of Lantern Capital has noted that the robust jobs report, which showed an increase of 254k, has had a significant impact on Treasury yields, a topic he has been discussing for weeks. The 2-year yield has risen by 22 basis points. Now standing at 3.93%, the bond market anticipates the Federal Reserve will reduce rates to 3.25% by March 2026. This would involve a 25-basis point cut at 7.5 of the 12 meetings between now and then. This is considered fair pricing given the Fed’s intention to gradually bring rates back to neutral.

Expectations of Rising Yields and Inflation Concerns

However, Hickman believes that such a significant increase is unlikely to be confined to a single day. He predicts that yields will continue to rise, particularly at the front-end of the yield curve, until negative economic data reappears. The narrative from Austan Goolsbee, president of the Chicago Fed, and Jerome Powell is that the Fed will reduce rates back to neutral (around 3%) regardless of economic weakness. However, inflation concerns may prompt Fed hawks to reverse the favourable financial conditions (low Treasury yields). Larry Summers, for instance, has argued that a 50 basis-point cut was a mistake. Hickman expects a member of the FOMC to suggest that a return to neutral should not be taken for granted. If this happens, the 2-year yield may become unstable. The jobs report represents a change in narrative that will take time to process before rates fall again in this Treasury bull market.

Recession Predictions Remain Unchanged

Despite the latest economic data, Hickman's recession predictions remain unchanged. He simply believes that it may be further away until more negative economic data emerges. The preconditions for a recession, including an inverted yield curve, a rising unemployment rate, and signals from the Leading Economic Index, are already in place. Historically, the presence of two of these signals has indicated a recession. In this cycle, all three have signaled a recession. The arguments against a recession are that it hasn't occurred yet, the Fed will lower rates before it happens, and there are no economic imbalances to correct.

Deficit Spending and the Business Cycle

In response to these arguments, Hickman points out that a recession may have been delayed due to large fiscal deficits. For example, the U.S. deficit to GDP in 2023 was 6.3%. The European Union, which began cutting rates earliest among the G-7 in June, had a lower deficit to GDP of 3.6% in 2023. The UK, which began cutting rates in August, had a deficit of 4.4% of GDP in 2023. This suggests that deficit spending can temporarily boost GDP growth, and the U.S., having spent the most among the G-7, may have delayed the business cycle.

Inflation and the Business Cycle

Secondly, the Fed is unlikely to be able to blindly cut down to neutral (around 3%) due to inflation concerns. Inflation is a concern at every step and is why the Fed can never get ahead of the business cycle. Today's comments by Larry Summers serve as a good example. The Fed needs to see escalating economic weakness as they cut to make them feel comfortable about inflation.

Imbalances in Risk-Markets

Finally, Hickman argues that the imbalance lies in risk-markets, such as the stock market. The S&P 500 has returned 16.9% annualized (total return, dividends re-invested) since the Great Financial Crisis low on March 6th, 2009. While it's not unusual for the stock market to go through 9-18 year periods with high returns, it has been 15.5 years so far. With the labor market deteriorating, Hickman believes a recession will start a long period of mean reversion.

Jobs Number and Recession

Today's jobs number fits into the volatility of a slowly deteriorating labor market and there are plenty of examples of big jobs numbers before recessions. For example, non-farm payrolls were +372k in February 1990, six months before that recession began. Payrolls were +268k in January 2001, two months before that recession began. And payrolls were +166k in October of 2007, two months before the Great Recession began.

Soft-Landing vs. Recession

Many people believe this cycle will result in a soft-landing, but the time-tested signals suggest otherwise. The incentives to be optimistic among nearly everyone build-up the soft-landing theme into a bigger thing than it is. In a recent interview with the President of the NABE (National Association of Business Economics), Ellen Zentner, Jerome Powell wouldn't acknowledge a soft-landing.

Bottom Line

Despite the strong jobs report, the signs of a looming recession remain. The narrative is changing, and it will take time to process before rates fall again in the Treasury bull market. The question remains: will the Fed be able to navigate the delicate balance between inflation and economic weakness? What do you think about this analysis? Share your thoughts with your friends and consider signing up for the Daily Briefing, which is available every day at 6pm.