Renaissance Macro Research
When Wall Street consensus in early 2023 was that a recession was set to hit the US economy in short order, Neil Dutta wasn't convinced.
The data to support such an outcome just wasn't there, the head of economics at Renaissance Macro Research argued in a July 2023 piece for Business Insider. Despite an onslaught of Federal Reserve rate hikes, continuing unemployment claims were low, monthly jobs reports were robust, and layoffs were muted, he wrote at the time.
About a year later, Dutta has changed his tune. In a July 11 article for BI, he wrote that the Fed should "hurry up and cut" to avoid a surge in unemployment that would throw the economy into recession.
Just weeks later, investors had a rude awakening that a recession could come to fruition when the July employment data sent the stock market into chaos in early August. Jobs gains had come in lower than expected, and the unemployment rate had risen to 4.3%, triggering the famed Sahm Rule recession indicator.
In a call with BI on Monday, Dutta reiterated his concerns about the path that the US economy is on following the weak labor market data. While he said the odds of a recession in the next 12 months are around 30%, the Fed and investors need to take this possibility seriously.
"I guess the question you have to ask yourself is, 'What about the current outlook suggests that things are going to turn around anytime soon for the labor market?'" he said.
Two signals that the labor market is trending downward are the decline in both the hiring rate and the quits rate, he said.
St. Louis Fed
The two statistics go hand-in-hand: softer hiring suggests demand from businesses for new workers is low, and lower quits suggest that employees are hesitant to leave their current roles amid a dearth of other opportunities.
St. Louis Fed
Both mean that wage growth is taking a hit, Dutta said, amid dampened competition levels. As of March 2024, wage growth's three-month moving average was down to 4.7% year-over-year from highs of 6.7% in August 2022.
Atlanta Fed
In addition, real incomes, which account for inflation, have been falling in the US since 2019. Prolonged drops in real income have typically occurred during recessionary periods. Real disposable income has also essentially flatlined since early 2023.
Given the stagnant job market and declining wage growth, Dutta described a potential vicious cycle scenario unfolding where slowing income growth leads to weaker consumer spending, which then leads to falling economic growth and higher unemployment levels, and so on. Consumer spending is responsible for around two-thirds of GDP.
The unemployment rate also tends to be "inertial," he said, as is shown in the Sahm Rule chart above. While Dutta's base case isn't for the jobless rate to continue to increase substantially, investors ought to consider that has usually been the case in the past.
"The historical record is the historical record. At a minimum, it should raise your concern dial meaningfully," Dutta said. "I definitely think that the risks to the unemployment rate are skewed to the upside."
To help stave off a recession, Dutta said that the Fed should cut rates by 50 basis points at its September meeting. Investors are pricing in a 67.5% chance of a 25-basis-point cut, according to the CME FedWatch tool.
Dutta said the next jobs report should not determine whether the Fed cuts by 25 or 50 basis points. On Wednesday, the Bureau of Labor Statistics said the US economy created 818,000 fewer payrolls in the year through March 2024.
"What this revision data imply is that whatever the next jobs number is going to be, it's probably lower in reality," he said in an email.
