I may have been the happiest person alive yesterday.  Why you ask?  Well, The Bureau of Labor Statistics had to finally admit that the employment data they published monthly for all of 2023 (likely through the rest of this of this year as well) was wayyyyyy off!  How off you ask?  Well, just under 70,000 jobs per month were overstated in the 12 months ended March, 2024.  Employment data will be reduced by 818,000 jobs in the January, 2025 benchmark revisions.  This was the second largest downward revision in history.  The only one larger was after the great financial crisis, where business bankruptcies and bank failures were well above historical norms and our recession was much longer than typical.  This was the largest overstatement during a supposed "booming economy."  Remember "Bidenomics?"

Yes, I am going to gloat a little because I have taken some abuse on this subject matter and my opinion on the actual health of the U.S. economy over the last year!  I first started pointing out the labor data discrepancies in in July, 2023.  I wrote a blog post back on July 11, 2023, that is still available for your review on this site, entitled "Getting Harder and Harder to Believe."  It was all about the large discrepancy between government data and private sources of labor data.  I then followed up with a series of posts that pointed out more labor and GDP discrepancy entitled "Bidenomics or BS?".

Why do I mention this today?  Well, because the window is still open.  By that I mean, this revision to the labor data is a revision to a coincident indicator, one that is used by NBER to officially date the beginning and end of recessions.  The chart below is busy I know, but it is starting to bring into question the theory of a Fed engineered "soft landing."  



The light blue line I call the window.  It is the Fed's recession probit model based on the spread between the 10 year treasury and the 3 month treasury yields.  It tends to lead recession by 12 months on average.  This line is pushed out to September of 2025 which incorporates the typical lead time.  That means the economy is still vulnerable to recession until that window closes.  The dark blue line is a model used by the St. Louis Fed that measures smoothed recession probabilities today, based on NBER coincident data.  It shows that as of June, we are still not in recession.  The maroon line is a probit model I built that marries yields and NBER coincident indicators together. As you can see, the maroon line is now above levels reached in both the 1990 and 2001 recessions.  That brings into question the soft landing scenario, especially given the really bad news on job creation data yesterday.

I bring this up because if the Fed thinks they have engineered a soft landing and only cut rates in 25 bps increments for the next few meetings, it likely won't be enough.  Stay tuned and thanks for letting me gloat a little!

The US credit cycle is entering a dangerous phase and it's time for the Fed to act sooner rather than later.  Rising interest rates by themselves are generally not enough to kill an economic expansion nor cause credit pain for community banks.  However, eventually rates rise to a punitive level for a given level of economic potential.  What is punitive? 

When the fed funds rate reaches a level where it provides a risk-free investment alternative to investing in instruments that fund business growth (bank loans, stocks, bonds) it can sideline investment dollars and slow economic growth and crimp earnings.  Once that happens, we generally see a marked deterioration in the employment environment which raises first, demand risk for products and services, but second credit risk for community bankers.  The unemployment rate is now above 4% and likely to continue rising

According to one of my best performing credit models over history (chart below) we have reached that critical punitive level.  The chart looks at the current environment for fostering credit demand and credit safety for banks.  When the environment is too hostile to foster credit demand, a red dot appears on the fed fund rate line.  Two dots in succession have led to rate cuts historically 100% of the time.  



I bring this up now because you have limited time to take advantage of the current levels of short rates before they disappear.  The odds of multiple rate cuts and soon are historically very high now.  Your duration decisions today on assets and liabilities will dictate the future direction of your margin, not the current level of your asset yields.   I will be expanding on this discussion further in next week's ALCOTalk newsletter.
 

There is a printing press war underway right now and the fight just got interesting for bankers.  One printing press, the Fed's, has been shut down since the SBV bank bailout in March of 2023. The Fed has raised interest rates and engaged in quantitative tightening in order to tighten financial conditions and slow inflation.  This resulted in a rolling recessions in the US in housing, trucking and manufacturing.  However, financial conditions lately have been easing, that's right, easing.  Why?  Washington evidently does not want a recession in an election year so they have their deficit spending money printing machine on full tilt to try and stave off an official recession.  It is no coincidence that the former head of the Fed, Janet Yellen, is in charge of the printing machine.  

So what just got interesting?  Well, if my leading model for the manufacturing sector, as represented by the ISM, is accurate, the manufacturing recession looks likely to end by early summer.  The sector has been in recession for 15 months but it appears that the contraction will end because the customer inventory cycle is fully depleted and needs to be restocked.  This is not a demand based resurgence, just a restocking cycle of the business sector.



This has future implications for the Fed, inflation and interest rates and really puts them in an uncomfortable spot.  Be careful what you wish for.  If we truly get a "soft landing", well, let's just say things get very uncomfortable for the banking sector for the rest of the year.  All eyes should now turn to the service sector, it is roughly 70% of the US economy now.  There are cracks in its foundation that I will discuss at great length at the 2024 ALMEdge user's conference.  I hope to see you all there!