One week ago, I surmised that signs of a softer labor market and consumer fatigue would raise concerns that the Fed is waiting too long to ease monetary policy, as fears of inflation give way to worries about weaker rates of economic growth. While we had plenty of signs of weakness in last week’s economic data, investors did not seem to be concerned, as the S&P 500 rose to a new all-time high. Bonds rallied on the weaker data, driving long-term yields lower, which helped fuel more gains for the technology sector. Investors may not be concerned yet, but my antennas are up for a policy mistake, as I think the Fed should start to reduce rates soon to get in front of a further deceleration in the rate of economic growth during the second half of this year.

It appears that the bond market agrees with me, as 2-year Treasury yields plunged to a three-month low of 4.61% last week, suggesting the market sees the need for a more aggressive monetary easing by the Fed. Still, that is no guarantee that the central bank will follow through. Chairman Powell and Fed officials have only one rate cut in their Summary of Economic Projections for the remainder of 2024, and they prefer to keep investors guessing as to when that might change to avoid fueling investor enthusiasm for risk assets. I think three rate cuts this year that begin no later than September would be sufficient to prolong the expansion, but anything less may put that outcome at risk. As I have noted for months, soft landings are balancing acts between just the right mix of economic weakness to tame inflation and strength to sustain growth. I am a lot more concerned about growth now.

I don’t think we need to see a further softening of labor market conditions to achieve our inflation goal. Every metric in last week’s jobs report is weakening. The three-month average of monthly payrolls has fallen to 177,000, which is probably still an overestimation. Wage growth has fallen to a three-year low. Weekly claims and continuing claims are rising. Revisions to prior months are largely to the downside.

For now, I am not concerned about the softening in the labor market. I think the unemployment rate is rising because more workers are entering the labor force rather than there being a sharp increase in the number of unemployed. According to the Sahm Rule, we have yet to receive a recession warning from the unemployment rate, as the three-month average rate (4.0%) is not 0.5% or more above the low from the previous 12 months, which is 3.6%. If that were to occur, it would be a reason for concern.

The monthly surveys by the Institute for Supply Management (ISM) of purchasing managers in the manufacturing and service sectors are both indicating contraction, but it is the service sector that is more notable, as it accounts for most of our economic activity. This should be a signal for the Fed to start taking its foot off the brakes of economic activity. I would be a lot more concerned if a similar survey from S&P Global were indicating contraction, but it is in expansion territory and has strengthened over the past three months. Still, the combination of the two is telling the Fed to act.

Furthermore, the ISM Prices Paid index has fallen to pre-pandemic levels, which indicates easing inflationary pressures for service sector companies. This sub-index leads consumer prices and is telling the Fed that disinflation should continue from what is already a 2.6% rate for its preferred inflation gauge.

Investors remain buoyant, but they do so through the perceived safety of the largest technology stocks, which is why the cap-weighted S&P 500 (SPY) has significantly outperformed the equal-weighted index (RSP) and the Russell 2000 small-cap index (IWM) since the bull market began in October 2022. This has given bears hope that the bull run is really a façade, but I think the lag in performance for most stocks is simply a function of investors waiting for confirmation that the US economy has landed softly. If it does, as I still expect, I think we will see this performance differential narrow dramatically.

In that capacity, this bull market is extremely young and there are tremendous opportunities still to be had, but the Fed needs to act soon to assure the expansion continues.