The data pointing toward a U.S. recession have been accumulating steadily over the past few weeks, and the release of the dismal September employment report on Oct. 3 has heightened the gloom. Nonfarm payrolls fell by a worse-than-expected 159,000 in September, the ninth consecutive monthly decline. The unemployment rate held at 6.1%.
Other components of the jobs report were even bleaker than the outsized payroll drop. The average workweek fell to 33.6 hours, from 33.7 the previous month. Average hourly earnings rose only 0.2%, which left the non-seasonally adjusted year-over-year figure at 3.2%, down from 3.6% in August.
The mix of payrolls reflected a worsening trend in services, with private service jobs falling more than goods-based jobs for the first time in the current downturn. Goods-based jobs fell 77,000, with manufacturing declining 51,000 and construction jobs losing 35,000. Private service jobs dropped 91,000, led by retail (-40,000), temp employment (-24,000), transportation (-16,000), and not surprisingly, financial services (-17,000).
The various components of the report combine to suggest rapidly deteriorating conditions across a broad swath of the U.S. economy. Soaring prices and collapsing banks appear to be finally affecting consumer and business behavior, just as the economy takes body blows from hurricanes, strikes, and the most recent credit-market freeze-up.
The total nonfarm and private payroll figures are showing accelerating declines that appear likely to continue in October, given the drop-back in the workweek, moderate earnings gains, a weakening mix of employment index readings in the various sentiment and confidence reports, and continued dismal initial claims readings.
The big September payroll drop, alongside a more important decline in the workweek and a lean wage gain, will take a chunk out of the other September economic forecasts, as well as the quarterly outlook for the year's end. It is now clear that the U.S. is in a recession that likely began in January, and which, it can now be assumed, will extend at least through yearend.
There's no longer a question about whether the downdraft pushing against growth will diminish and stop short of a full-fledged recession. Instead, the risk now is that the downturn will be substantial rather than modest. The weakness reflects a deterioration in conditions that began during the last two months, and likely reflects both the powerful hit to households' real income from soaring prices and the seizing up of credit market conditions for borrowers who had previously seemed able to skirt financial dislocation.
For the Federal Reserve, there will be mounting talk of either a rate cut in the U.S. or a globally coordinated move to ease rates—either is possible. But we continue to believe that Fed inflation hawks in particular, but likely other voting members of the Fed Open Markets Committee as well, have come increasingly to believe that the rate reductions since the start of 2008 provided little help, neither lowering borrowing costs to the public nor lessening the pressure on banks. The rate declines have had some unwelcome effects, contributing to the dollar's steep decline and powerful commodity price surges.
Harmfully Low Rate
In short, an excessively low Fed funds rate target has been as much a harmful influence on the markets and credit spreads through 2008 as a helpful one. As such, our assumption will be that at upcoming meetings, the FOMC will hold the Fed funds rate target at 2%, while waiting to see the beneficial effects of asset purchases under the U.S. financial-system rescue plan passed by the House on Oct. 3. The hope is that the plan will allow borrowing costs in the economy to subside as credit spreads narrow.
The Fed funds rate has undershot the central bank's 2.0% target in 9 of the last 10 days of heightened market turmoil, leaving an effective rate for the past two weeks of just 1.34%, and a 1.56% average since the Lehman Brothers failure in mid-September. If market conditions hold, this reduction in the Fed funds target can be sustained without the Fed even having to make a move, while the Treasury organizes the first of its toxic-mortgage purchases. If the Fed soon starts to pay interest on reserves it holds for U.S. banks, the rate it pays on those reserves will place a floor on how low the Fed funds rate can fall.