Stocks get stronger while labor market gets weaker. What’s next?

BRIAN HESS: What am I missing?

JACK JANASIEWICZ: Yeah, no. Good question. Because if you do have the answer, you can let me know, because I might be missing it as well.

JACK JANASIEWICZ: I'm Jack Janasiewicz.

BRIAN HESS: And I'm Brian Hess. This is Tactical Take.

JACK JANASIEWICZ: OK.

BRIAN HESS: All right, Jack. Well, August was another strong month for risk assets. And this time it was small caps, mid-caps, value stocks turned to shine. Bonds had a positive return too after the CPI report for July and Chairman Powell's speech at Jackson Hole. So, it was another strong month, like I said, for risk assets. And a 60/40 portfolio, if you're just using the S&P 500 and the AGG (Bloomberg U.S. Aggregate Bond Index), up high single digits already through August. So, I guess my question is, have you been surprised by the strength in risk assets coming off the April low? I'm not afraid to say that I definitely am surprised that we're at 6,500 on the S&P 500.

JACK JANASIEWICZ: Yes and no, I guess, is maybe how I'd frame that. It's not surprising, given just the sentiment that was offsides. And so, whenever you get a sentiment that's that bearish, it sort of puts the floor underneath the market, and I think, puts some support in. So, it's not surprising we could see the market rally up here.

To put up close to double digit gains at this point, that's probably a little bit of surprise. I think we were certainly optimistic for the markets. And one of the things that we've been talking about quite a bit in stuff we've been writing, as well as our conversations with clients, maybe we are underestimating that flexibility of corporate America. Their dynamism, the ability for them to adjust on the fly. Maybe we have underappreciated that. Because certainly, the concerns we've been seeing with tariffs really haven't manifested quite as aggressively as I think most people have expected. And I think that's a hat tip to corporate America.

And so, again, surprised, yes. But to a lesser extent, no.

BRIAN HESS: Yeah. I guess the de-risking back in April was just so powerful. And it happened so quickly, which is why I think it was easy to underestimate it, because it was just a span of a few days of selling. But I guess it was just such tremendous de-risking that it led to the sentiment wash out that you talked about, which set up the stage for this big recovery.

Now, in our models, we've been somewhat defensively positioned most of the year. I'd say since February, we started to de-risk. And we put a little bit more risk on during the correction in the March, April time frame, but we've never really gotten ahead of the market in terms of grasping that risk profile of being aggressive.

Are you inclined to chase the rally here, or do you think, well, now we've priced in so much good news that the balance of risk is skewed to lower the downside again?

JACK JANASIEWICZ: Yeah. And listen, we've been certainly talking about some consolidation for a couple of months now. And a lot of that was based on the idea that the labor market was slowing. And at some point, the market would probably overextrapolate any sort of weakness in the labor market into something a little bit more concerning. I think we've been maybe early on that and we're finally starting to see that manifest. But the flip side to that is I think the market's gotten ahead of itself in terms of pricing in that tug of war between slowing economic data, slowing labor market, and the potential for the fed to actually come back and start easing.

And so we've been sort of positioning for that consolidation, that chop. Maybe really hasn't manifested. And now, we're certainly seeing that pivot by the fed, which is, I think, supporting the market going forward. So I think that's maybe where we're a little bit off in terms of the timing on that.

BRIAN HESS: But the macrofundamentals seem like they might be moving in that direction. So let's follow that thread. Because the main reason why we've been defensively positioned has been that we've been expecting a slowdown in the economy. And, even though the stock market might not reflect that it's traded up in almost a straight line since the April lows, there's definitely been economic weakening. And now it's broadened out to include the labor market as well.

So we have the big negative revisions for the May data and the June data, which created underwhelming job creation for those two months. July was a good month, a reasonably good month of job creation. But then we just got the August report last week. And once again, it's a disappointment. So if we look at job creation since that tariff announcement in April, it's been really modest-- May, June, July, August cumulatively.

So I guess how concerned are you about the US labor market? And here in Natixis have we marked up our recession odds meaningfully as a result?

JACK JANASIEWICZ: So, maybe to answer the second question first, have we marked up those recession odds? No, because I think the answer to the question on that front would be the rate cut cycle. And I think it's certainly, coming off of Jackson Hole as well as comments that we've heard from voting members over the last couple of weeks, the more hawkish members of the committee are certainly pivoting towards openness to cut. So it certainly sounds like the easing bias is about to commence. The easing cycle is about to commence. And we'll see that probably over the following three meetings going into the end of the year.

So I think that gives a little bit of support for the markets going forward. But I will say, though, that the risk that still looms out there-- and this is something that Fed Governor Waller has talked about-- when you start to see a deterioration in the labor market, that can sometimes not necessarily be this linear cooling that we keep talking about. It can actually start to accelerate to the downside. And so I still think that might be one of the key risks in here. We really haven't seen firings. We've certainly seen slowing in hirings. But if that were to start to shift, and we start to see a more pronounced deceleration in the labor markets, that might be the incremental risk that we might see that could lead to a proper correction here.

BRIAN HESS: Right, Jack. So if you look at a chart of the unemployment rate, historically, it typically bounces around at a low level for a long period of time. And then when it starts to rise, it rises very rapidly. That's what you're talking about with respect to the asymmetry.

And we have not seen that. It's been a very gradual rise in the unemployment rate so far. 

One thing I'd like to point out is that one of our favorite macro indicators is a proxy for spending power in the economy. And there we look at the growth rate in job creation, in average hourly earnings, and in hours worked. And when you combine this and look at the year over year rate of growth, it's a pretty good indication of the spending power being created in the economy. I'm sure you've seen the latest print after Friday's jobs report, and that metric is now down to 2.4 year over year.

And so that's the lowest level of the post post-COVID era. I haven't seen that number yet since prior to COVID. And the average rate during the last decade was 4.5%.

And so we're now 2 percentage points off that level. And what we find with this indicator is that it's typically either growing 4% to 5%, or it's negative and we're in a recession. And so we're in a bit of a no-man's land here at this 2.4%. And if we don't get some kind of pickup in one of those three variables, it's hard to imagine consumption providing a big contribution to GDP growth. And if we get any worsening and we turn negative on that metric, then I think the recession probabilities will have to be raised. Because that's at least historically been the template. You get negative growth of that metric, and it's really hard for the economy to expand.

JACK JANASIEWICZ: Yeah. And what's interesting about that household paycheck proxy-- that's our nickname for it-- in the past, we've sort of had, of those three variables, usually one of them is the one that's the culprit for leading to the weakening there. And the more recent data, it's really all three of them have been filtering through that weakness. And so that's certainly a red flag, or a yellow flag, if you will.

But I would take it even one step further. And, that number-- when you compare that to what the fed funds rate is, you'd like to see them kind of growing roughly at the same pace.

BRIAN HESS: That makes sense.

JACK JANASIEWICZ: And so as an arbitrary number that sort gives us an indication of how tight monetary policy could be, we're trading significantly below where that fed fund rate is. And so from that perspective, I think you could argue that there is certainly plenty of room for the fed to ease. And that's one of the things we would point to on that backdrop.

BRIAN HESS: Yeah. And that's where I want to go next is to talk about the Fed. But thinking back to last cycle, I mentioned the average for that indicator was 4.5% I think the average policy rate was probably 0% for that decade.

[LAUGHTER]

So you're talking about 450 basis points of negative real rate on that basis. And now we're at positive 2 percentage points with a 4.5% fed rate versus 2 and 1/2 roughly for that indicator. So yeah, that's speaking to perhaps some tight monetary policy. Stock market doesn't care. But–

JACK JANASIEWICZ: Yeah. And the only other thing I might add to that is just when we look at the credit card data, for example, from all the major banks, we're still seeing consumers spend. So the question is, how long does it take for that to seep its way into those kind of numbers? So we're not seeing it yet, but it's certainly again, like we said, yellow, red flags being thrown up with that number.

BRIAN HESS: Yeah. Something to pay attention to and probably makes us more keen to be watching like the Redbook data, which you put in our chat this morning, or Walmart's earnings, which you put a note out on, I think it was last week.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: So we'll transition to the Fed now, because I guess the silver lining of the economic slowing is that-- and also the moderation of wage growth that feeds into that metric we were talking about-- is that it does give the Fed the green light to lower interest rates, and they have the space to do it with the upper band at 4.5%, as I just mentioned. So, we've got the September meeting next week and market odds for a cut are over 100%. So, I'm sure you're expecting one too. We're not going to take the other side of that. But any chance of a 50 basis point cut, do you think?

JACK JANASIEWICZ: Yeah, I think the market may be getting a little bit ahead of itself. I want to say this morning, maybe the odds of a 50 bipper was, I think, around 18%. So, we're certainly moving well, well beyond 25. We're starting to talk about 50s. But I just think when you look at a lot of the more hawkish members, that was just more recently, for them to pivot from being hawkish to at least getting a 25 basis point cut is a big bar. And I think we finally cleared that. But to have them move all the way to a 50, that's probably a little bit aggressive.

So I think we'd be hard pressed to see a 50 basis point move from the fed at the upcoming meeting. So again, we're still in line with a series of 25 going forward.

BRIAN HESS: But a series. If they start, they're going to do more than one. There's no reason to–

JACK JANASIEWICZ: Exactly.

BRIAN HESS: --cut one time, especially when you're at 4.5%. OK.

So the other thing, I guess, when we have these Fed meetings is the press conference is critically important. Anything you'll be looking for there. Let's say we get the 25 basis point cut. We got the summary of economic projections. We got the new dot plot. Chairman Powell comes out and gives his press conference. Anything in particular you think either the market will be focusing on?

And by the way, by the time this podcast is out, it'll probably have happened. So we'll see what we were thinking. And hopefully, your comments will be helpful for people to interpret what they've already heard.

JACK JANASIEWICZ: I think the big one will be the dot plot, the summary of economic projections. I think people are going to be curious to see what that neutral rate will look like going forward, and do we start to see those dots coming down. And it's a bit of a forward guidance indicator as well. So I think the market will be paying attention to that. And we'll see if Stephen Miron will end up having a vote at that time. Where was his dot emerge? I think we can guess–

BRIAN HESS: We'll guess. We'll be an outlier. Where is that low dot?

JACK JANASIEWICZ: Yeah, exactly. But I think that'll be the key is what the S&P says, and how much do those dots shift lower at the end of the day.

BRIAN HESS: OK. That sounds good and makes sense. Now the last time the Fed cut rates, which was September through December of last year, 2024, we had an interesting thing take place in the bond market where long term yields actually rose. And they rose meaningfully. It wasn't just like a small blip. There was like a trend higher in rates throughout the entire fourth quarter, while the fed was cutting, which is really pretty unusual.

And since then, long term yields have risen all over the world. 30-year bonds have generally underperformed. They're clearly out of favor. Now when the fed started cutting rates last time, the 30-year yield was below 4%. It was just below 4%. So, it was pricing in a much lower rate environment, I would say, from that level. And today, we're looking at a 30-year yield around 470. So, a big difference in terms of the starting level for yields.

The other thing is that the macro backdrop has shifted a bit, I would say. The Fed was cutting in 2024 because inflation had come down. Growth was still holding up really well. We were still constructive on the growth outlook. That's why we were overweight stocks all of last year. But inflation just kept coming back towards their target. No need to have such a tight monetary policy.

This time, it seems to me, like they're cutting based on economic weakness. They're worried about the labor market, just like what we were talking about. So the macro backdrop is different. 30s have been trading in a range for the past four months between 480 and 5. They've taken three runs above 5%. Each of them have failed. Twice earlier in the year, they made runs-- or a run at 5%, and both of them were rejected as well.

So, we've had five rejections of 5% in 2025. We've got the fed expected to start cutting rates next week. And it seems to me if the 30-year yield couldn't rise above 5% while the Fed was on hold, and we had tariff-related inflation uncertainty, just creating a lot of skepticism about the fair value for yields and what the inflation environment would look like, how are they going to do it while the Fed is actually cutting rates and as it seems like some of that tariff uncertainty has passed?

So, I know the curve typically steepens when the Fed is cutting interest rates, but we've already seen 2s 30s steepen out by 60 basis points here to date. Same thing is true for 5 30s. The curves over 100 basis points steep for both of those combinations 2s 30s and 5s 30s. And yields have been rejected at 5% a bunch of times, like I already mentioned.

So, with Treasury yields breaking down through the bottom end of that range last week-- we were trading 480 to 485. We're now 470. We had a clean break last week. It seems to me there could be a really good tactical opportunity setting up at the long end of the US yield curve.

JACK JANASIEWICZ: Yeah.

BRIAN HESS: What am I missing?

JACK JANASIEWICZ: Yeah, no. Good question. Because if you do have the answer, you can let me know, because I might be missing it as well. What's interesting, I think there's a bunch of different reasons why, or at least what people are talking about as to why the 30 has really remained pinned at that upper level, so to speak, whether it be the infamous catch-all term premium.

BRIAN HESS: Right.

JACK JANASIEWICZ: You even hear a lot of the conversation about, well, the Fed's going to run the economy hot. So they're still probably going to be some inflationary concerns, which might cause some of that repricing in the back of the curve. You hear about concerns about, just issuance going forward.

There's plenty of things you can point to. But I honestly think when it comes down to the fundamental backdrop, right, it's all about growth and inflation. And if we're starting to see signs of a decelerating economy, it shouldn't be a surprise that maybe we start to see that curve come in a little bit.

And so, maybe the steepener has run its course at this point. And I think that's somewhat of a consensus trade. So maybe the argument might be that we get a little bit of a flattener, and in this case, the 30 actually comes in a little bit more. The 10s maybe a little bit as well, but maybe not as much.

BRIAN HESS: Yeah, 10's 30s has steepened out as well.

JACK JANASIEWICZ: Right. And obviously the front of the curve is already pricing in quite a few cuts. So maybe that doesn't move as much. So from a consensus perspective that would be maybe one of the arguments I would have where maybe we do get a little bit of a bull-flattener going forward in here. It's simply that that steepener is a consensus.

You know, what's interesting, I was actually looking earlier this morning. You had mentioned just the global nature of the backup in the yield curves, the steepening around the world. You'd mentioned too that 30s at 470. We started the year, I think at 475.

We're the actual one major developed bond market that has actually seen its 30 tighten year to date. Everybody else is actually wider. And you look at Japan, Japanese 30s are almost 100 basis points wider. And the German Bund, almost 70 basis points wider.

So interesting little backdrop there in terms of what we're seeing globally. So, it's not just a US phenomenon where we're seeing the steepening. It's global. It just happens that we were sort of coming from, I think, a much different starting point. And that's, I think, making the big difference in the bond markets right now.

BRIAN HESS: It is really interesting, because the German yields have backed up quite a lot.

JACK JANASIEWICZ: Yep.

BRIAN HESS: But the European Central Bank (ECB) was cutting during that time period.

JACK JANASIEWICZ: Yeah.

BRIAN HESS: So that's sort of like what happened with the Fed when they did their cutting cycle last year. I just think from a risk reward standpoint, the 30s in the US are an interesting idea. I mean, number one, they're a relative strength leader, as you mentioned, outperforming a lot of other countries.

But the market's priced for a terminal rate of around 3% right now. So if the 30-year is at 5% again, making a sixth run of it, and the Fed ends up cutting to 3%, you've got 200 basis points of steepness priced, which is a pretty extreme level for a 3% policy rate.

If rates were at 0% I could see 200 basis points of steepness or beyond very easily. But it seems from a 3% policy rate that would be enough steepness to make those yields attractive.

Whereas on the other hand-- and that's an environment we're assuming the economy has a soft landing and growth holds up. But if our paycheck proxy goes negative and it ends up with a recession in the US, then I think the downside for 30-year yields is significant.

JACK JANASIEWICZ: Yeah.

BRIAN HESS: So maybe they have a little bit of upside room from here, but potentially a lot of downside if the macro picture worsens.

JACK JANASIEWICZ: And I think you're framing it right. It's really that risk reward skew, right. What are the odds of the 30-year pushing higher? And as you framed it, it's sort of like we threw a lot of bad news out already and you couldn't get it to break 5.

What's probably more likely in here? Maybe a whiff of worse economic backdrop? Yeah. And I'm guessing that would probably pull the curve in.

So I think from your perspective on that and framing it that way, your upside is, we probably could see yields rally versus your downside, maybe we're just going to be pinned at something closer to 5% but nothing really more so. And from that perspective, that makes a pretty good skew.

BRIAN HESS: I think so too. Now you've been on the road a little bit, meeting with clients. And so I thought I'd ask about any kind of talking points that came up frequently or any pushback against our views? Maybe people were saying the long end of the curve's attractive on the road. I doubt it. But maybe.

JACK JANASIEWICZ: No. You know, yeah, you're right. I've been on the road quite a bit, meeting with clients, doing a lot of speaking events. A couple takeaways that I found interesting on my travels and conversations with clients, there is still a healthy dose of skepticism.

People are, I think to me, sort of recycling some of the old wall of worry, if you will. We hear a lot about, is the AI trade a bubble? Valuations are becoming an issue. It's basically kind of the same stories that we've been hearing.

And whenever I sort of get that wall of worry feeling from clients, to me it tells me that at least there's room for them to add. So from that perspective, what's the pain trade? The pain trade might be actually for it to grind up. I know a lot of people have been expecting a pullback.

And we always argue that we're probably buyers of something closer to a 5% correction. And what tends to happen, you get a 5% correction and a lot of clients will say, well, I'm going to wait for 10%. And guess what? We never get to the 10% because everybody's looking to step in.

BRIAN HESS: Yeah.

JACK JANASIEWICZ: That might be setting up for the same backdrop as well, because it certainly does feel like, A, people are still skeptical on this. B, now you're going to start to see the rate cuts kicking in. So maybe they're feeling a little more comfortable because the Fed's going to be supporting them. And then they're going to be looking for that pullback to add on.

So maybe that pullback is more shallow than people think, and maybe you only get 2% or 3%, 4% pullback. And I was going back and looked, I think the biggest correction we've had post Liberation Day in the S&P, 2.7%.

BRIAN HESS: Wow.

JACK JANASIEWICZ: So we aren't having those drawdowns that we're typically seeing over the course of a full year, outside of the big move we had at Liberation Day.

BRIAN HESS: And we're what, 30% off the lows or something?

JACK JANASIEWICZ: Yeah, exactly.

BRIAN HESS: So to go 30% with only a 2.7%, if you think about it in those terms as opposed to months or trading days or something, that's pretty impressive.

JACK JANASIEWICZ: And again, let's look at vol, right. The move index, which is looking at the implied 30-day implied vol across the Treasury curve normalized to all time lows. We haven't been here, I think, since 2022. And the VIX is pushing 15 with a 14 handle.

Those aren't things you typically see when things are about to explode, right. And credit spreads at all time tights or at close to historical tights. That's telling you something.

BRIAN HESS: Yeah. There's either a lot of recognition by markets that things are better than we worry about, or there's a lot of complacency in the markets, one way or the other.

JACK JANASIEWICZ: Sure. Exactly.

BRIAN HESS: We're to find out. Last thing, because you mentioned a topic I just would like to hit on before we wrap, and that's this notion that maybe the AI trade is exhibiting bubble-like characteristics.

I mean, I could just be a skeptic or maybe I'm overly cautious, but it seems to me like the speculative evidence is starting to pile up. And there's a lot of things reminiscent of prior bubble periods that are happening now.

Like, for example, this week I saw some stock up 3,500% because they put Dan Ives as Chairman. And that's more of like a crypto related thing. But it does have AI involvement as well. I mean, that's kind of a classic example, companies attaching AI to their name and seeing the stock surge. We saw that happen with the crypto markets a few years ago before it had a big correction.

So what do you think? Are you worried that we're in some kind of speculative mania here?

JACK JANASIEWICZ: Certainly can appreciate the concerns there. And we've been watching the earnings commentary like a hawk for those companies on the CapEx (capital expenditures) front. We've talked about it for the second quarter. CapEx spend was a huge contributor to GDP growth, contributing more than what we had for consumption.

So if you think about consumption running, whatever, $20, $21 trillion, that's a pretty big base to impact GDP on. When you talk about AI spend, it's small.

BRIAN HESS: Right.

JACK JANASIEWICZ: But just because you had that rate of change, that change on a quarter on quarter basis was so big, it had such an impact.

Now we start to fast forward to what we heard the other day from Oracle. It certainly doesn't sound like any of this stuff is about to change anytime soon. So–

BRIAN HESS: And Oracle's up 40% as we're recording this.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: We should mention.

JACK JANASIEWICZ: So, again, we're certainly on watch because that AI trade starts to roll over, that's going to have a lot of-- it's going to bring a lot of people down with it. So certainly keenly aware of what's going on there.

But, again, paying attention to the comments that we're hearing from a lot of these CEOs and the hyperscalers, it's still game on it seems like. So, are there? Not yet. We're certainly well aware of the risks that are associated with that. We're paying very close attention to watching what these guys are saying. But right now there's no signs of it slowing.

BRIAN HESS: So we're just not seeing a crack in the fundamentals. We recognize valuations are demanding and sentiments really frothy, but the fundamentals continue to deliver.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: And that's what we're paying attention to.

JACK JANASIEWICZ: And what's the old adage? You know, the market can stay irrational longer than you can stay solvent. Maybe this thing can run a lot farther than we think. And, you know, we'll see. We'll ride it as long, but we're certainly on top of the radar in terms of concerns that we're paying attention to.

BRIAN HESS: Yeah, it could be. It wouldn't be the first time I was early with something.

JACK JANASIEWICZ: Yeah.

BRIAN HESS: Thanks, Jack. We'll see you next month.

JACK JANASIEWICZ: Pleasure. Good.