September 2024 Market Commentary

September 26, 2024

• Markets fell at the start of August, rattled by unexpectedly weak economic data.
• The Federal Reserve ended its rate hike cycle, cutting rates by 0.50% in September.
• August Returns: S&P 500 2.3%, Bloomberg US Aggregate Bond Index 1.4%.

August got off to a rocky start, with the S&P 500 falling over 6% during the first three trading days of the month; the selloff was initially triggered by a spate of disappointing economic reports showing unexpected weakness in the manufacturing sector and labor markets, compounded by an unwinding of the yen carry trade. Ensuing data, and comments from Fed Chair Jay Powell all but ensuring a rate cut at the Fed’s September meeting, led to a sharp rally during the remainder of the month.

Economic data released during the month pointed to continued growth, albeit with some signs of slowing. Encouragingly, second quarter GDP data was revised up from 2.8% to 3.0%, indicating the economy entered the third quarter with strong momentum. July retail sales surged 1.0% from June, the strongest monthly gain since January 2023 and another sign that the consumer refuses to concede to higher prices and interest rates.

One area that has been particularly vexing to economists is the labor market. When the Fed initiated its rate hike cycle in March 2022, it acknowledged that its efforts to cool inflation might result in economic “pain,” widely understood to mean slower economic growth and increased unemployment. However, as the Fed aggressively pursued its rate tightening cycle in 2022 and 2023, economic activity consistently exceeded expectations, while unemployment remained at or near historically low levels.

One area that has particularly vexed economists is the labor market. When the Fed initiated its rate hike cycle in March 2022, it acknowledged that its efforts to cool inflation might result in economic “pain,” widely understood to mean slower growth and increased unemployment. However, as the Fed aggressively pursued its tightening cycle in 2022 and 2023, economic activity consistently exceeded expectations, while unemployment remained at or near historically low levels.

Of late, however, there have been growing signs of labor market weakness. Determining just how weak, has been difficult. Since reaching a low of 3.4% in April 2023, unemployment has increased 0.8%, reaching 4.2% in August. However, much of the increase has been fueled, not by individuals losing jobs, but by an increasing number of individuals entering the labor force in search of work, arguably a good thing. At the same time, there has been a noticeable disconnect between the nonfarm payroll data and household survey data, both of which are included in the monthly employment report. Specifically, for much of the year, nonfarm payroll gains have consistently exceeded job growth reported in the household survey data. The disconnect was reinforced in August, after the government completed its annual revisions to nonfarm payroll data, showing that for the 12 months ending March 2024, 818K fewer jobs were created than initially indicated. The revisions reduced the monthly average job growth from 242K to 174K.

Other data has been less ambiguous, including the number of job openings, which has steadily declined from 12.2M in March 2022 to 7.7M in July. At the same time the ratio of job openings-to-unemployed individuals has fallen from 2.0x in March 2022 to just under 1.1x in July. The steady decline indicates businesses’ cooling demand for labor. Despite the higher unemployment, weaker job growth, and slowing demand for labor, at least for now, weekly unemployment claims have remained low suggesting no meaningful increase in the pace of layoffs.

Inflation cooled over the course of the summer with the headline consumer price index (CPI) slowing from 3.0% in June to 2.5% in August. Core CPI, excluding food and energy prices, saw more modest improvement, slowing from 3.3% to 2.5%. Housing remains the largest contributor to inflation, accounting for over 70% of August’s increase. Though it hasn’t materialized as quickly as expected, slowing rent growth should ultimately be reflected in the official inflation data in the coming months. One area that has experienced notable declines is used vehicle prices which fell 10.4% in August from a year ago, the third consecutive month of annual declines in excess of 10%.

The combination of improving inflation and slowing labor conditions led Fed Chair Jay Powell to announce in August that “The time has come for policy to adjust” because as he noted, “The upside risks to inflation have diminished. And the downside risks to employment have increased.” That rationale served as the basis for the Fed cutting rates by 0.50% at its September meeting.

Despite the large decline at the outset of August, markets quickly recovered thanks to additional and more positive economic data, along with Powell’s confirmation that the Fed intended to cut rates at its September meeting. For the month, large caps (S&P 500) returned 2.3%. Small caps (Russell 2000) slid 1.6%, weighed down by renewed recession fears spurred by the weak economic data released at the start of the month. International markets enjoyed positive returns in August, led by developed markets (MSCI EAFE) which rose 3.0%. Emerging markets (MSCI EM) gained a more modest 1.4%.

Fixed income rallied over the course of August, with both the 2-year and 10-year U.S. Treasury yields falling to new 12-month lows. The primary catalyst was the July employment report, released just two days into August, which underwhelmed by nearly every measure. Unemployment rose to 4.3%, its highest level since October 2021, while nonfarm payroll additions missed expectations and prior month’s figures were subject to large downward revisions. The disappointing labor data triggered both a flight to safety as well as the market pricing in much more aggressive Fed rate cuts. With employment data lagging and inflation showing signs of approaching the Fed’s target, the market assumed the Fed would need to cut rates rapidly to complete an economic “soft-landing”.

After the initial shock of the employment report abated, other more encouraging economic data calmed some recessionary fears and re-introduced the case for a slower pace to the Fed’s upcoming rate cuts. Stronger than expected retail sales, robust ISM Services data, and stabilized initial jobless claims all helped lift yields off their early-month lows by assuaging concerns of a rapidly deteriorating economy. Spurred by Powell’s Jackson Hole comments regarding changes to monetary policy, the 2-year Treasury yield ended August at 3.92%, a drop of 0.25%, while the 10-year Treasury ended at 3.91%, 0.07% below where it began the month. The larger move in the 2-year Treasury yield vs. the 10-year Treasury yield reflected the greater impact that monetary policy actions have at the short end of the yield curve vs. the long end of the yield curve.

Municipal bonds experienced a similar rally after the employment report and Powell’s Jackson Hole comments. The 2-year AAA Municipal yield fell 37bps over the month, while the 10-year AAA Municipal yield fell 8bps on the month.

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