Highlights for this week include:

• We continue to see signs of softness in the labor market and slowly falling inflation. This is consistent with the Federal Reserve (Fed) cutting interest rates at next week’s meeting with the market assigning the highest probability to a 0.25% cut.
• The NFIB Small Business Optimism Index, while low by historical norms, remains consistent with economic growth. The Atlanta Fed is now estimating healthy third-quarter economic growth of 2.5%.
• Recent corporate bond market performance is also consistent with positive economic growth. Given still positive economic growth and the fact that corporate profits and future estimates of them remain sturdy, we view recent stock market action as a consolidation in an ongoing bull market. Stay tuned, and see below for details.

Further Cooling of Labor Market Conditions

While the August jobs report fell modestly short of expectations, it showed a rebound from July (which helped spark the early August market selloff). Nonfarm payrolls expanded by a less than expected 142,000 in August, which was somewhat offset by a rebound in the average workweek back to 34.3 hours. July’s weather-related impacts reversed in August with the household survey showing the number of employed rising by 168,000, while those unemployed fell by 48,000. As a result, the unemployment rate fell to 4.2% from 4.3%.

Average hourly earnings picked up 3.8% from a year ago, with gains in both goods and services industries. Combined with payrolls and hours of work, this translated into a 5.0% y/y increase in aggregate payrolls, which is a proxy for labor compensation. The pace has been relatively stable so far this year and remains supportive of moderate personal income and spending growth – consistent with further economic growth.

This report is consistent with other labor market reports, including the recently released JOLTS report that continues to show falling job openings and the Conference Board’s Employment Trends Index (ETI), which has been on a downward trajectory consistent with slowing job growth. While none of these are weak enough to signal a recession, they are consistent with the Federal Reserve cutting interest rates at its meeting next week. The Fed has made it clear it doesn’t want to see further weakening of the labor market.

Further Slow Progress on Inflation

The Consumer Price Index (CPI) rose 0.2% in August, the same as in the previous month, matching expectations. On a y/y basis, the headline CPI fell to 2.5% from 2.9% in the month before, while core CPI (excludes volatile food and energy) was steady at 3.2%, and both were at or near their lowest levels since the spring of 2021. Lower energy prices were the major contributor to lower headline CPI inflation, with underlying price pressures remaining sticky, which suggests a longer process to reach the Fed’s 2.0% inflation target.

While the Fed has shifted its focus from fighting inflation to supporting the labor market, inflation trends suggest a slow easing cycle. The market is now assigning the highest probability to a 0.25% interest rate cut at the Fed meeting next week.

Small Business Optimism Remains Consistent with Moderate Economic Growth

The NFIB Small Business Optimism Index fell 2.5 in August for its first decline in five months, bringing the index back within its range since mid-2022. Although it is low by historical norms, sentiment is still consistent with moderate economic growth.

Meanwhile, the Atlanta Fed’s GDPNow model is estimating that third-quarter economic growth will come in at a healthy 2.5% rate.

Thoughts On Recent Market Dynamics

Stocks remain in a trading range since the July high and September is historically the weakest month of the year for stocks. In addition, the rotation toward the defensive bond surrogates that started with the early August weakness continues. There are other signs of caution, including weakness in the deep cyclical Energy and Material sectors. However, positive performance coming from Industrials and Financials, sectors that typically underperform during periods of economic weakness, remains an encouraging signal.

There are also positive signals coming from the corporate bond market. The cost and availability of credit is critical for a healthy economy and, consequently, for financial markets. Rising credit stress ultimately weighs on economic growth and risk asset, therefore we follow credit conditions closely.

The classic measure of credit stress is an increase in corporate bond yields relative to risk-free Treasury bonds (corporate credit spread), particularly for non-investment grade bonds. The higher yield of corporate bonds is required to compensate investors for default potential, which rises during periods of economic stress. Importantly, investment-grade and non-investment-grade corporate credit spreads remain near historical lows, suggesting that stocks and the economy remain on solid footing.

Given the positive economic growth that we continue to see and the fact that corporate profits and future estimates of them remain sturdy, we view the recent market weakness as a consolidation in an ongoing bull market. Stay tuned for future updates as things develop.