Market mood remains cautious ahead of US jobs data

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US equity market sentiment has been fragile since the recent string of weaker economic releases rekindled recession fears. The Wednesday release of the Beige Book, in which Federal Reserve officials gather opinions from business leaders and economists across the country, pointed to a cooling of demand. “Consumer spending ticked down in most districts,” the Fed concluded, while more regions reported “flat or declining activity.”

This followed the release of the ISM manufacturing activity report, which came in below expectations. In addition, data this week showed job openings for July falling to their lowest level since January 2021.

But the most influential release of the week is likely to be today’s August employment report. The prior month’s disappointing jobs release sparked fears that the Fed had waited too long to cut rates, and that as a result, the US was headed for a recession—or was already in one. Over the past month, investors have been debating whether the rise in unemployment was due to hurricane-related disruptions or genuine economic weakness.

We will be looking to several aspects of the report to help settle this question.

A moderation of unemployment would help ease recession concerns. The main source of anxiety in the July jobs release was the swift rise in joblessness, which climbed from 4.1% in June to 4.3%. This is up from a multi-decade low of 3.4% as recently as last spring. The speed of the increase has triggered fears about the "Sahm rule," which holds that a recession has already started when the three-month moving average of unemployment climbs by 0.5 percentage points or more from its low over the prior 12 months. However, this may have been a false signal, in our view.

The consensus forecast is that the jobless rate for August should edge lower to 4.2%. Such an outcome could reassure investors that the labor market is cooling only gradually, and the more abrupt slowdown registered in July reflected the temporary impact of Hurricane Beryl.

A pickup in jobs could also improve confidence in a soft landing. In July, the US economy generated 114,000 net new jobs, below the market expectation of 175,000 based on a Reuters poll. That is down from 272,000 as recently as May. Here, too, the consensus forecast is for a modest revival, with job growth accelerating to 160,000 in August.

This would be consistent with our view that demand for labor continues to moderate without drying up too suddenly. A sharp decline in employment, however, would provide a clearer indication that an economic contraction is underway.

An improvement in average earnings would support consumption. Solid consumer spending is key to averting an economic contraction, in our view. With the US personal savings rate at historical lows and likely to rise, earnings growth is likely to be key to supporting consumption. Average hourly earnings growth slowed to 3.6% annually in July, down from 3.9% in June. The consensus is for this metric to accelerate slightly in August to 3.7%. Here, investors are likely to be looking for signs that wage growth is stabilizing, without being so strong as to revive fears over inflation.

So, given the importance of the employment data, investors should brace for volatility in the wake of the release. Our base case remains for a soft economic landing, though recession risks have increased. We recommend focusing on long-term financial plans and ensuring adequate diversification. In addition, we see value in allocations to alternatives for those willing and able to manage the associated inherent risks. Certain hedge fund strategies, for example, have historically demonstrated their ability to stabilize portfolios and generate returns during periods of elevated volatility.