US labour market/economy and dilemma of FED

Last Friday US jobs data looked surprisingly strong and as a result of it unemployment data went a bit lower to 4,1 percent. We should put this into a context of an ever expanding budget deficits and some other technical factors. Let me explain the situation a bit. Employment in the US has barely moved up in the past 1 year and as a result of it unemployment rate has nudged up by a notch . In the past 12 months US government has pumped in an about 400 B USD additional liquidity into the US economy and most of it has been injected in the past 4 months. At the same time by adjusting the ADP survey and BLS date we see, that about 50K/month is artificial job creation. Continuous large payroll revisions are not without reasons, it is partially a result of the extremely large illegal immigration, which is slowly filtering into the US economy, but another part of the constant revisions are at least suspicious.

1.) Election, budget/debt deal , USTR general balance and effects of those on growth

The past 12 months of 400 B USD fiscal pump priming is enough to create about 1 M jobs within 12-18 months, which means, that job growth will stay close to 100K until the end of 2024 even in case of zero or negative private investment growth. Given, that we see some additional fiscal spending due to Hurricanes, we should be sure, that US economy has enough momentum until 2025 January. Given, that fiscal deficit in 2024 has grown by 1,5 percentage points compared to 2023, we can be sure, that in 2025 the US government cannot create such stimulus without wrecking the bond market. Such constellation points to substantial economic slowdown from January of 2025. This date coincides with the expiration of US debt ceiling, which could mean, that a slowdown is around the corner, but we should not forget, that Yellen has boosted the US Treasury Balances to 800 B USD, which is roughly 300 B USD above where it should be. It is also important to know, that US government still does not have an official budget for 2024/25 AND ONLY A SHORT TERM SPENDING BUDGET DEAL HAS BEEN AGREED, this quick fix expires by mid of December, meaning that US should have a debt and budget deal by that time.

2.) China, BRICS, ME are potential Black Swan events, slowdown is guaranteed, but inflation can come back anytime in 2025, if fiscal and ME are not properly handled .

Given, that the US election is held in November and new administration will be inaugurated only on January 20th, it is almost guaranteed, that the US treasury will run down its Treasury Balance by a minimum 3-400 B USD in the next 2 quarters. All these means, that artificial boost to the US economy will stop in this quarter, meaning that labour market can rely only on the private sector in the next 6-9 months. Given, that effects of former stimuluses will run out by the end of 2024, the US economy will enter a rough patch in the first half of next year. Although the strong Chinese stimulus will have some stabilizer effects on the global economy, but firstly it only slows/halts the downward spiral of the CHINESE economy, but its current size is not big enough to push up global growth rate and direction of the next phase of the Chinese stimulus depends on the upcoming US election and on the BRICS meeting. The Chinese economy can/will help the US and Global economy only after it is able to stop the slide of its real estate sector, which takes minimum 6-9 months more.

The Hurricane Helene and Milton will take off about 100K from non farm payroll growth in October/November period, which will lead to maximum 100-120K payroll growth in the last quarter of 2024. Given, that US needs roughly 200K job growth just to keep unemployment stable all this will mean, that unemployment rate will move back up to 4,4 percent by the end of this year and we can enter an economic recession sometime in the first quarter of 2025. Although rundown of US treasury balances can postpone the US recession by 1 or 2 months, but all the above mean, that US will enter to a sub 1 percent growth territory already in the first quarter of 2025 and there is a more than 75 percent chance, that US will enter into an at least technical recession sometime in the 1st or 2nd quarter of next year.

3.) No fiscal cuts, means higher inflation and a potential bond crash

The real problem comes, if the next administration decides not to cut deficit and let the budget deficit to run above 7 percent of GDP, since in such case core inflation will stop to drop under 2,7 percent and will start to bounce back already by mid of 2025, which could mean, that FED cannot cut rates under 4 percent. Powell is right to be cautious, since inflation is nowhere close to be dead and we can be sure, that the Chinese economy will stop to be a deflationary force from 2025 H2. All the above assumes, that ME stays stable(no big war) and oil price (WTI) will not move over 76-78 ceiling. IF ME blows up ( it is impossible to keep it calm without minimum 300 B fresh funds to be immediately and properly deployed), then the situation will get very problematic, since in such case oil price will move over its previous 75-95 USD range. Although personal income growth and government spending is enough to keep the US economy to move ahead in the next 3 months, but a lot depends on the US election and ME.

Although potential explosive events of ME have a big say who will win the US election, but underlying economic fundamentals suggest, that no matter whoever wins the US election a strong economic slowdown is inevitable. It is certain, that US will have subpar growth in the next 2 years, if the slightest fiscal responsibility returns. The problem is the inflation, if ME blows up, then inflation will come back earlier and FED and ECB cannot cut more than 50 bps from here, which will prolong an inevitable strong economic slowdown in the DM world. The high US budget deficits puts a long term upward pressure on inflation/on real rates and makes bond market rallies under 4 percent difficult to sustain until the deficit is not tackled.

4.) Chinese stimulus will help, but cannot cure the deficit cancer

Due to strong Chinese stimulus I give 20 percent chance for a US soft landing (more than 1 percent, but less than 2,25 percent annual economic growth in 2025/2026), but potential ME explosions raises chance of a mega recession(more than 1 percent economic contraction in the next 2 years)coupled with higher inflation (more than 4 percent in 2025/26) to 35 percent. I keep a chance of hard landing (less than 1,2 percent economic growth between 2025Q1 and 2026Q3) 45 percent. I still see a very small chance that inflation can be pushed under 2,5 percent in the next 18 months without geopolitical calm. US stocks are very even more overpriced than before and although technicals are still pointing upwards, but we are skating on a very thin ice there. There are many other much cheaper markets than US equities and it was not without a reason why Chinese stocks have outperformed US this year and such trend will continue.

We are at a binary situation, either major countries will understand, that without cooperation economic problems cannot be sorted out or we will end up in a major crisis in the developed economies.

Peter Heim

Budapest