Eating Their Own?

A Troop of Trouble: In a market priced for perfection, any hint of trouble can cause a disruption, and with the S&P trading at over 20 times earnings, that is what is unfolding. The sources of volatility include uncertainty over Fed policy and worries over employment, with politics continuing to loom over AI and the chip sector (the main market drivers recently). Additionally, renewed Yen strength threatens to disrupt the lucrative carry trade once more, which was the trigger for the first downdraft in early August. Any one of these would be enough to cause selling, but with all of these happening at once, you get a market like we have had over the last few weeks. None of these elements appear to be abating soon, so expect continued choppy markets. Caution and reduced beta in portfolios is prudent at this time.

Challenging Environment

Undoubtedly, the weakness in the revised nonfarm payroll numbers caught the market’s attention Friday. However, the most interesting piece of data regarding AI displacing jobs was buried in another report from the day before. The outplacement firm Challenger Grey & Christmas’ August job cuts report showed a sharp increase in the number of existing employees companies fired, reversing a four-month decline. Excluding 2020, this August’s firings were the highest of any August since the Global Financial Crisis. The company said its data suggests “growing economic uncertainty and shifting market dynamics.” The cuts were classified by employers as the result of cost-cutting and market/economic conditions, which fits with the shrinking profit margin theme we have been discussing lately.

But the bad news did not stop there. Challenger also tracks hiring, and their year-to-date total hiring plans through August is the lowest since they began keeping records 19 years ago. It is lower than the total hiring plans that were logged from January through August 2008, when the world economy was mired in a deep recession.

There was an even more troubling datapoint in the August report: technology companies announced the highest job cuts since January 2023, and the cuts were driven by AI adoption and automation across roles and functions. It was only in April 2024 that Challenger first reported that employers listed AI as the cause for letting workers go, and we wrote about it then. Since then, AI as the reason for firing staff has accelerated, and 80% of the total AI firings since April occurred in the most recent report. Technology companies are obviously the early adopters of AI within their organizations, and the fact that they are firing workers at an increasing rate as they begin to roll out AI applications paints a troubling long-term view for the U.S. workforce. As we said in April, this is significant, and we will keep an eye on this trend.

China’s Stealth Intervention: Potential Timebomb

China made a big mistake nine years ago. They blew through $650 billion of their currency reserves selling dollars against the yuan to support their currency in 2015. Now, in 2024, they have turned to a different strategy to prop up the yuan. Beijing has enlisted its state banks to enter transactions called foreign exchange swaps, where they sell dollars and buy yuan to strengthen the currency. Estimates range that these swap positions have ballooned to $100-$400 billion, and this strategy has only just recently surfaced; the Chinese government may be sacrificing their own banks in initiating this strategy by generating this new exposure.

The enormity of the transactions pushed swap prices to an extreme, so this market irregularity created sizable losses for China’s state banks, hurting their share prices and shareholders. There are two mitigating factors for China’s financial institutions: the Chinese banks can delay booking those losses by rolling into new swaps, and those losses have been trimmed somewhat as the dollar has fallen recently on expectations of Fed rate cuts.

President Xi wants a strong yuan despite the need for a cheaper currency that helps their exports grow, something their fragile economy relies upon. A continued weakening of the Yuan could generate a rush of capital out of the country, which must be prevented, considering the steady fall in Foreign Direct Investment (FDI) into China. FDI went negative in Q3 2023 for the first time in decades, so domestic capital flight is of heightened importance to Beijing. Because a strong yuan has been a stated goal of Xi’s, don’t expect the swap activity to taper in the foreseeable future. Their banks are vulnerable if these sizable swaps drop in price. This means any sharp rise in the USDCNY (Yuan weakening) resulting from a Chinese economic slowdown or a global recession will create losses on the books of the state banks, putting them in danger of a dramatic stock selloff at the worst possible time.

WW 2

New York Fed President Williams and Fed Governor Waller spoke after the disappointing employment data Friday, and the message was clear: help is on the way. However, will it be as much as investors demand? Both Williams and Waller are permanent Federal Open Market Committee (FOMC) voters and confirmed Chairman Powell’s declaration that the Fed will cut rates this month. Williams said, “Now is appropriate to lower the fed funds rate” and Waller agreed that “The time has come to begin reducing the policy rate at the upcoming meeting.” 

The questions remain as to whether the Fed cuts 25 or 50 at the September 18 meeting, how many more cuts are to be expected, and when. Williams said, “I am not ready to say how big the first rate cut should be,” perhaps because he spoke just 15 minutes after payrolls were released Friday morning. Waller had more time to look at the data and went a step further, saying he “will be an advocate for front-loading rate cuts…and would also cut at consecutive meetings if data calls for it.”

For now, investors are betting on only a 25-basis point cut in September, and stocks remained depressed based on this view. This sets up a dynamic where further economic softness will bring in lower stock prices unless the Fed convinces the market they are ready to cut rates fast to respond to recession risks. If equity investors believe the Fed will do more than enough to avoid a recession, then stocks can stage a solid rally.

What to Look for This Week

1. More important than inflation data this week could be Initial and Continuing Claims due Thursday, September 12, 8:30 a.m. E.S.T. It will be the last piece of employment data out before the FOMC meeting, and any renewed upswing in the data could push the FOMC meeting debate toward a 50-basis point cut.

2. Wednesday, September 11, 8:30 a.m. E.S.T. the Consumer Price Index is released. Core CPI has been dropping steadily and if it drops from June’s 3.2% to under 3%, sentiment could shift to expecting a 50-basis point cut. PPI out on Thursday.

3. Thursday, September 12, 8:15 a.m. E.S.T. the European Central Bank announces its rate decision and Monetary Policy Statement. 30 minutes later, President Christine Lagarde will likely discuss their decision to cut 25 basis points, dropping policy rates from 4.50% to 4.25% in June and now to 4.00% in September.