New jobs numbers raise alarm bells on recession risk

• Usually, it is a warning sign that a recession is imminent.
• It is a sign that the Federal Reserve has erred by delaying the onset of interest rate cuts. Given the delays with which Fed policy affects the economy, the new numbers suggest the Fed should have started adjusting policy to act as less of a brake on the economy months ago.

The impact: Markets reacted accordingly Friday morning.

• The S&P 500 was down 2.5% as of 11:30am ET.
• Ten-year U.S. Treasury yields have plunged to 3.82% — from 4.5% on July 1 — as markets now anticipate significant rate cuts in the coming months to combat incipient economic weakness.

What they're saying: "Yellow flags had started to pop up in the labor market data over the past few months, but now the flags are turning red," wrote Nick Bunker with Indeed Hiring Lab in a note.

By the numbers: In isolation, the July numbers are not so bad. The alarm is in the direction of travel, and in the presence of warning signs from other pieces of data that usually get less attention.

• The unemployment rate is 4.3%, up from 4.1% in June — still low. But historically, when the unemployment rate moves up as much as it has this year (the rate was 3.7% in January), it doesn't stop there.
• Employers added 114,000 jobs in July, not too bad given that the economy has been near full employment — but that represents a significant deterioration so far this year. Over the last six months, job growth has averaged 194,000 jobs a month, down from 251,000 in 2023.
• This week alone, new data showed the rate at which companies hired new workers declined in June, the number of people filing jobless claims reached its highest level in 11 months, and business activity for manufacturers plunged in July.

Yes, but: There are some mitigating factors that you can point to if your glasses are of the rose-tinted variety.

• The size of the labor force expanded by 420,000 people in July, implying greater supply potential for the economy as those people find jobs.
• Higher unemployment was driven by workers on temporary layoff, which implies they may soon return to work.
• Hurricane Beryl hammered Texas last month and likely dragged the numbers down in the nation's second-most populous state.

Reality check: There are always caveats and one-off events affecting the jobs data, which can make it especially hard to parse at economic turning points.

Fed officials who argued behind closed doors this week that the central bank should cut rates immediately are surely experiencing a serious case of the toldya so's.

• But the big question moving forward is how aggressively the Fed will react to the deteriorating job market.

Between the lines: Chair Jerome Powell, in his news conference Wednesday, downplayed the idea that the Fed could cut rates by a half percentage point at its September meeting, saying "that's not something we're thinking about right now."

• But if the August jobs data, due out Sept. 6, were to show the same kind of weakness as the July numbers, the Fed would likely take seriously the possibility of such a supersized move (as opposed to the quarter-point cut long anticipated).
• When you're behind the curve, after all, you have to move faster to catch up.

State of play: Markets are now pricing in a likelihood of a half-point rate cut next month. The odds, via CME's FedWatch tool, were 76.5% on Friday morning, post-jobs report, up from 22% Thursday.

• "The across-the-board weakness in the July employment report further fuels the view that the Fed is late to easing monetary policy," wrote Nationwide chief economist Kathy Bostjancic in a note.
• Although "Powell threw cold water on the prospect of starting the easing process with a 50bps rate cut, that is a clear possibility if the data continue to show a quickly deteriorating economy."

The bottom line: In monetary policy, as in life, there are no do-overs. But for the Fed, the next best thing may be to make up for lost time by cutting more aggressively than its leaders had envisioned.