Boom Or Doom?

07 August 2025

In late June we argued that “although the unemployment rate remains low, partial indicators of the labour market (job openings, temporary hires, monthly revisions, and layoffs) undercut the resilient labour market narrative. The Challenger layoffs time series now rival the readings from September 2008 right before the systemic rupture went mainstream. The data might indicate fragility under the surface: where headline strength masked a rolling deterioration. Just like in 2008, we may be mistaking lagging indicators (like the unemployment rate) for structural health, when leading indicators (job cut announcements) are screaming stress.”

July employment released last Friday reported 258,000 in downward revisions to the prior two months. Trend employment growth to slow to just +35,000 over the past three months and like early 2008 (chart 1). It was also the largest two-month downward revision since 1968, outside NBER recessions. Private payrolls were running at a low but healthy pace of around 110,000 per month from January to April this year. However, from May to July that monthly pace dropped to 50,000 per month.

Chart 1

Source: Bloomberg

Note that the productive sectors (outside healthcare such as wholesale, retail trade, manufacturing, and business services) have been shedding jobs in the last three months. The uncertainty caused by the tariff policies and trade negotiations have likely contributed to private sector layoffs. On the positive side, with lower uncertainty some of these trade related seizures could reverse. Moreover, tax cuts, de-regulation and the absence of fiscal consolidation could support the labour market in the second half.

The weakness in July employment was also reflected in the ISM service sector report. The employment sub index was reported at 46.4 (in contraction). There was also a poor growth-inflation trade off reported in the ISM survey. New orders were reported at 50.4 while the prices paid sub index rose to 69.9 with parallels to the episode in 2007 leading into 2008 (chart 2).

Chart 2

Source: Bloomberg

The lack of fiscal consolidation in the Big Beautiful Bill and the persistent political pressure on the Federal Reserve has likely contributed to a rise in 5-year forward inflation expectations and a widening in the bond term risk premium. The Administration has chosen to run the economy hot rather than endure the detox. Ironically, the “good outcome” for bonds would be a sharp slowdown in employment as that would likely lower inflation expectations looking forward (changes in employment tend to lead inflation). If the August employment report is similarly weak at the start of September, the Fed will likely cut the funds rate by 50 basis points at the next FOMC meeting. Of course, that is now priced into short term interest rates.

The challenge for equity markets in this context is that the S&P500 (global risk proxy) trades at 22.9 times forward earnings and in the 90^th percentile of its 30-year valuation history. Credit spreads, especially in the high yield market, also under-price left tail risk. The internals of the stock market (concentration, crowding and the performance of cyclicals relative to defensives) also suggest that the risk-reward is not attractive in the near term. Put another way there is also a divergence between price and fundamentals. As a result, we remain tactically cautious in our risk allocation. Hopefully, the tactical outlook will resolve itself either way over the next six weeks.

20250806_Boom_Or_Doom.pdf

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