8/2/24 – The steepest yield curve in two years

We had two closely watched events this week, the FOMC rate decision and the monthly employment report, and neither disappointed in terms of market impact.  As was widely expected, the FOMC left the overnight interest rate unchanged, with Chairman Powell strongly suggesting that a rate cut would be coming at the September meeting.  Throughout his post-meeting press conference, he emphasized the Fed’s dual mandate of full employment and stable inflation.  We interpret that as a concern that the employment backdrop has become a worry.  The employment measures this week validated that concern.

The ADP employment report, released Wednesday, showed that the economy added 122,000 jobs in July, below the 150,000 expected, and the fourth consecutive monthly decline.  Similarly, on Thursday, initial claims for unemployment insurance registered 249,000 last week.  Bad weather in Texas explained some of the move, but the measure is clearly trending higher.

Capping the string of weak employment reports, the non-farm payroll measure released this morning showed the economy added 114,000 new jobs for the month, well below the 178,000 expected.  Most alarming though was the unemployment rate, which rose to 4.3% in July.  That’s 0.8% higher than the rate registered last summer and by some, a harbinger of a recession lurking just around the corner.  We don’t share that concern, but the weak employment data paired with Chairman Powell’s words have made a September rate cut a foregone conclusion.  Some pundits are forecasting that they will cut rates by 50 basis points.  While that is a distinct possibility, the current committee doesn’t like to surprise markets and such a move would need to be telegraphed well in advance.

The capital markets are responding to the downbeat news accordingly, with the S&P 500 down more than 2% for the week, the 2-year Treasury note yield-to-maturity 48 basis points lower, and the 2-year/30-year yield curve is closing the week at a positive 21 basis points. That’s the steepest the curve has been in two years.  To put the steepening into perspective the 2-year/30-year reached a near-term peak of 229 basis points in early 2021.  If the Fed is about to embark on a cycle of easing, we expect that the curve will continue to steepen.

Next week is a light one in terms of economic data releases and the same goes for Fed speeches.  With that in mind we expect that market moves will be driven by a follow-through on todays’ outsized move.