Mixed Data Leaves Fed With a Murky Path Forward

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Markets finished on a high note last Friday but still ended a choppy week in the red. The lackluster showing came during a heavy week of major economic data that offered a muddled picture of where the economy is headed. Initial estimates of third-quarter Gross Domestic Product (GDP) signaled solid growth for the just finished quarter, while the September jobs report from the Bureau of Labor Statistics (BLS) showed that hiring slowed dramatically. Adding to the muddled view was that some of the reports (including the jobs data) were likely affected by hurricanes Helene and Milton, which made landfall in the U.S. in September, as well as an ongoing strike at Boeing that has led to layoffs and has likely had a trickle-down effect on suppliers in the aerospace industry.

While conflicting data has become common over the several months, we continue to focus on how the various reports are likely to influence the Federal Reserve’s views on its dual mandate of supporting price stability and maximum employment. On that front, data put out last week likely did little to derail an expected 25-basis-point rate cut at this week’s Federal Open Markets Committee meeting.

The latest reading of the Personal Consumption Expenditures (PCE) index from the Bureau of Economic Analysis showed that headline inflation rose 0.2 percent in September and is up 2.1 percent on a year-over-year basis. The pace is just slightly above the Federal Reserve’s stated target of sustainable readings of 2 percent.

Core inflation, which strips out volatile food and energy prices and is the measure that the Fed has the greatest influence over, rose 0.3 percent in September—in line with Wall Street estimates but up from August’s pace of 0.2 percent. On a year-over-year basis, core inflation was up 2.7 percent, unchanged from August’s year-over-year pace and slightly above consensus estimates. This marks the fourth time in the past five months and the third consecutive month the 12-month reading has come in at 2.7 percent.

The cost of goods declined 0.1 percent. Services prices rose by 0.3 percent, up 0.1 percent from August’s level. On a year-over-year basis, inflation for services came in at 3.7 percent, down from August’s reading of 3.8 percent. This marks the fourth consecutive month that services inflation has registered year-over-year growth in a range of 3.7 to 3.8 percent and suggests that progress in the disinflationary process has once again slowed.

Given the stability in the core reading over the past few months, we expect the Fed will still cut rates this week but may slow the pace of cuts eventually should this figure remain elevated. This is particularly likely if the economy continues to show signs of solid growth going forward.

While inflation data offered the Fed a largely consistent view as it relates to the price stability side of its mandate, employment figures were less conclusive. To be sure, last week’s BLS Nonfarm payroll report fell well short of Wall Street expectations with just 12,000 new jobs added in October versus consensus estimates of 100,000. The latest figure was also significantly lower than the average monthly gain of 194,000 seen over the past 12 months. While normally a report this weak would set off alarm bells, investors largely shrugged it off because the two hurricanes in September along with a major strike at Boeing make significant revisions to the data almost certain. While we agree the headline number should be viewed with skepticism, we believe some of the details of the report still hold value when viewed in the context of longer-term trends.

For example, the latest release shows jobs gains for August and September were revised down by 112,000 in total. Downward revisions have been commonplace during the past year, with totals in seven of the past nine months coming in lower than initially estimated. In total, revisions have shaved a total of 422,000 positions, or roughly 47,000 per month, from initial estimates.

The latest report also shows that positions in the private sector declined by 28,000 for the month. Additionally, temporary help services—a leading indicator of the broader labor market—fell by 48,500. This is a timely measure because employers typically let go of temporary workers before cutting permanent staff. Once again, it is important to note that these figures are likely distorted by 44,000 employees out of work due to the Boeing strike as well as a yet-to-be determined number who did not work due to the hurricanes. However, the trend for private employment has been weak, with three of the four months prior to this report showing job gains of fewer than 100,000.

The BLS’s other jobs report, the Household survey, also showed some erosion of strength, with the unemployment rate rising by .09 percent from 4.051 percent to 4.145 percent. As we’ve often seen during the past year, the Household survey estimates of positions are materially different than those found in the Nonfarm report. Typically, the Nonfarm data and the Household estimates can vary over short periods of time, but eventually the gap narrows. Given the trend in nonfarm payrolls revisions over the past 18 months, we believe it is likely the final estimates will be directionally more in line with the Household survey.

So where does all this leave the Fed? In our view, the Federal Open Markets Committee (FOMC) is where it has been for the past several weeks—concerned about possible weakness in the job market but also wary of reigniting core inflation readings that are stubbornly elevated. The uncertainty and conflicting data also raise the risk for investors. The temptation to bet on a soft or hard landing may seem appealing. However, we believe investors would be well served by not rushing to conclusions. Instead, we believe investors should follow an investment plan for which an unexpected twist or turn doesn’t have an outsized impact on the long-term success of achieving their financial goals.

We believe the approach discussed above is also prudent for investors who may be tempted to make significant changes to their portfolios in response to the results of this week’s election. As our research shows, performance of the markets is far more dependent on where we are in the economic cycle when a new president and congress takes office than it is on any party or candidate. That’s because at almost $29 trillion, the U.S. economy is too big and complex to significantly sway from its natural trend rate of growth.

Wall Street wrap

More on the employment picture: Announced job cuts in October totaled 55,597, up 51 percent from the same month a year ago, according to the latest report from Challenger, Gray & Christmas Outplacement Services. This marks the seventh month this year that announced job cuts were higher compared to the same month in 2023. In total, nearly 665,000 job cuts have been announced, which is the most in the first 10 months of a year since 2020 (when COVID struck) and, before that, the most since 2009. The year-over-year jump in cuts comes as the number of announced new hires year to date is now at the lowest level since 2016 as recorded by the outplacement firm since the report’s inception in 2005. The latest data shows 750,333 new positions announced year to date through October, with 659,850 attributed to seasonal employment.

Manufacturing weakness continues: The latest headline reading from the Institute for Supply Management (ISM) shows that manufacturing activity remains weak, with October’s measure at 46.5, down 0.7 points from September (readings below 50 indicate contraction for the sector). The latest level marks the seventh consecutive month of contractionary readings and the 23rd time in the past 24 months that the reading has been below 50. Readings for new orders remained at contractionary levels, coming in at 47.1, up one point from the prior month. Order backlogs fell further into contractionary territory at 42.3 compared to 44.1 for the prior month.

The employment index continues to signal shrinking payrolls, with the latest reading at 44.4, up 0.5 points from September. The July, September and October readings are now among the three lowest readings for the measure since July 2020. Weak demand for employees was widespread, with 10 of 18 industries reporting a decrease in employment and only one of the six major industries (food, beverage and tobacco products) reporting an increase. The report showed a one-to-three ratio of hiring versus job reductions in the manufacturing sector. The data showed manufacturers are being pinched between slowing sales and higher input costs. The latest reading for input prices rose to 54.8, a jump of 6.5 points from September's contractionary reading of 48.3.

Much like last week’s Nonfarm payroll data, the ISM report may be clouded due to the impact of two hurricanes in October. However, the latest results are directionally consistent with the trend for this report for the past several months. In comments released with the report, Tim Fiore, chair of the ISM, noted, “Demand remains subdued, as companies continue to show an unwillingness to invest in capital and inventory due to concerns (for example, inflation resurgence) about federal monetary policy direction in light of the fiscal policies proposed by both major parties.”

Consumer confidence jumps: The Conference Board’s Consumer Confidence rebounded to 108.7 in October, 9.5 points from September’s revised reading of 99.2. The rise was the largest recorded since March 2021 but is still within a tight range that has persisted for the past two years. Consumers’ assessment of their present situation rose 14.2 points to 138. Likewise, their expectations for the future increased 6.3 points to 89.1. The improvement in views was widespread as each of the five categories measured by the survey showed improvement.

After months of weakening views of the labor market, respondents’ outlook toward job prospects improved. The labor differential, which measures the gap between those who find it hard or easy to get a job, rose to 18.3 from September’s reading of 12.7 percent. Still, the level is well below the record high level of 47.1 recorded in March 2022. Prior to the most recent report, this has significantly weakened over the past few months. Since March of this year, the differential has dropped by more than a third from 29.5 to its current level. We will be watching to see if the October reading marks an inflection point or represents statistical noise.

The improved outlook may be the product of the Fed’s September rate cut and recent strength in the stock market. Indeed, 51.4 percent of consumers expect stock prices to increase in the year ahead, marking the highest reading since the question was first asked in 1987. Interestingly, regarding the Fed rate cut, the number of those who expect rates to be higher next year rose to 47.5 percent, marking the first increase after four consecutive months of decreased readings.

Solid GDP growth: The initial estimate of third-quarter real gross domestic product (GDP) growth from the Bureau of Economic Analysis came in at 2.8 percent, lower than Wall Street expectations of 2.9 percent. The increase was driven primarily by strong consumer spending, which was up 3.7 percent. Business fixed investment spending was another bright spot, accounting for 0.46 points of the total growth figure. Meanwhile, residential investment declined 5.1 percent during the quarter, as elevated home prices and high interest rates continue to put homebuying out of reach for some consumers.

The week ahead

Tuesday: The Institute for Supply Management will release its latest Purchasing Managers Services Index mid-morning. Given that the services side of the economy has driven much of the economy’s growth over the past two years, we will be looking for signs of any changes in underlying strength in this report.

Thursday: The focus for the day will be on the Federal Reserve as it releases its statement following what is widely expected to be a rate cut. We will be listening to Federal Reserve Chaiman Jerome Powell’s post-meeting press conference for insights into how the Fed views the state of the job market and what he has to say about the pace of cuts going forward.

Friday: The University of Michigan will release its preliminary report on November consumer sentiment and inflation expectations. We will be watching to see whether the rise in sentiment captured in the October report has staying power.

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