Unpacking Jobs Numbers, Fed Intentions, Coronavirus

The U.S. Labor Department reported a sharp decline in job openings on Tuesday. The number came in at 6.2 million, down by more than 1.1 million since October, and the lowest in two years.

So, here's the question: Amid mostly good "other" job market indicators, is the plunging number of job openings something to worry about?

But that's not all. We have the situation in Europe, which may be more vulnerable to the Wuhan coronavirus disruption. In fact, even before the spread of the virus, things were looking rough for European manufacturing. We also have Federal Reserve Chair Jerome Powell, who came out and said policy isn't on a pre-set course, but then gave us several reasons why cuts are more likely than hikes.

That's a lot to take in, so let's unpack it all. Here are some thoughts on how the global economy is trending and what it means for markets.

Yes, Job Openings Are a Troubling Sign

It is getting harder to clearly state that the job market is A-OK. There are two legitimate ways to look at the plunge in job openings. On the positive side, total openings remains higher than the total number of unemployed people. So, if we assumed every opening was real and anyone could fill any opening, we still couldn't fill all available spots. It's worth noting that this very positive condition had never happened prior to 2018.

On the negative side, not only has the absolute number of job openings fallen, the ratio to total unemployed people has risen and seems to be on an upward trend.

Survey data on hiring intentions has been mostly steady to declining. The National Federation of Independent Business' small business survey had hiring intentions at up 19, down from an up 21 average in 2018. The Institute for Supply Management non-manufacturing hiring intentions number is 53.1, which is still in expansion mode, but down from 56.4 this time last year. Manufacturing has plunged to 46.6, which is outright contraction and down from 55.2 last year.

All this paints a picture of a slower pace of job growth and probably also reflects somewhat less business optimism. As I've written before, the economy has never persisted with low-but-positive job growth. In the past it has always happened that once job growth slows to a certain point, it indicates the economy has hit a stall speed and we fall into a recession. I've estimated that trigger at about 0.7% growth over a 6-month period, which translates into approximately an increase in 170,000 jobs per month right now.

Companies stop hiring and stop investing in capital. That in turn hurts aggregate demand and viola: Recession.

Could this time be different? Companies only keep hiring if they think demand for their product will grow. Once that confidence declines, it can become self-fulfilling. Companies stop hiring and stop investing in capital. That in turn hurts aggregate demand and viola: Recession.

I suppose there could be something to Powell allowing unemployment to fall further than past Fed chairs would have, and at some point we literally run out of workers. But on the other hand, economic growth requires both demand and supply to keep growing. If we actually run out of workers, that's going to get tough. I'm not sounding the alarm bell so much as I'm saying we should stop just blithely saying the labor market is an unmitigated positive sign.

Europe Will Feel Virus' Effect Long Before U.S.

The Wuhan coronavirus remains unlikely to have a large, or even perceptible, impact on the U.S. economy. But it could matter quite a bit in Europe. China is the second largest export market for the combined Eurozone, and Germany alone accounts for more than half of those exports. Indeed, Germany's sales to China are almost equal to the U.S.' despite the fact that Germany's is a quarter the U.S.' size. In economics, concentrated pain is usually worse than small amounts of pain spread across a wider group of firms, so this is a major problem for Europe. While I don't see this as a huge risk to U.S. gross domestic product (did you even notice when Europe had a recession in 2013?), it will matter for U.S. interest rates. Demand for U.S. bonds from Europe is substantial, and a nascent reflation story in Europe was a major reason why U.S. rates rose in 4Q 2019. If core European rates fall further, demand for U.S. bonds will only get stronger.

Meanwhile, things aren't great for European manufacturing as it is. The December Eurozone Industrial Production report was released Wednesday showing a 2.1% contraction in December. That's before there was any effects from the virus. A similar report for Germany itself was released last week, showing a 3.5% contraction. Now these manufacturing reports can be very volatile, both in Europe and the U.S., so this comes with the normal caveat to not overweight a single report. But suffice to say there are considerable risks of things getting worse for Europe before they get better. 

Fed More Likely to Cut Than to Hike

Fed Chair Jerome Powell testified before both houses of Congress this week. I didn't take much away from his remarks, but if you were still doubting that rate cuts were far more likely than hikes, his testimony should remove those doubts. While he took pains to emphasize that the current rate target will probably "remain appropriate" for the time being, almost all of the conversation was about reasons why the Fed might cut. Inflation is too low, "spill over" from "significant distress" in China, and the risk the need to head off recessions before they happen given how low rates are.

As I've been saying for the last year, if the Fed isn't going to hike, there isn't much room for longer Treasury rates to be higher. Right now Fed funds is 1.58%. The 10-year Treasury could trade 20 basis points to 30 basis points higher than that if it was believed that the Fed was on hold forever, but if the market becomes sure the next move is a cut, 10's will soon trade below Fed funds. Moreover, I strongly believe that once the Fed starts cutting, it is almost assured it will cut all the way to zero. This makes intermediate-term bonds quite attractive even at these low rate levels. 

At the time of publication, Graff was long 5-year, 10-year and Ultra 10-year Treasury futures.