U.S. equity markets have fallen for two weeks in a row due, no doubt, to the uncertainty introduced first by the Chinese DeepSeek company which announced an uber-cheap AI model that initially sent Nvidia and other AI stocks reeling (NVDA down more than -18% in January’s last week; recovering about half of that in the market week ended February 7th).6 10 Microsoft (MSFT) shares also tumbled on the DeepSeek news,7 11 while Meta hit an all-time high.2 12
As noted in the next table, the tech heavy Nasdaq led the way down over those two weeks, but not all the decline can be blamed on DeepSeek and AI.
Part of the markets’ nervousness stems from the uncertainty surrounding President Trump’s tariff program and the uncertainty surrounding his policies in general.3 4 Markets abhor uncertainty. Initially, markets interpreted Trumps 20% tariff threats on Mexico and Canada as bargaining chips that were unlikely to be implemented.5 6 But when the tariff threats became reality, markets became unnerved.5 They calmed a bit when those tariffs were put on a 30-day hold (bargaining chips – Trump style),8 9 but we are likely to see more market nerves as the end of the 30-day period of reprieve approaches. Then on Monday (February 10th), Trump put 25% tariffs on steel and aluminum imports.3 13 While, in the long run, that may cause more domestic production, in the short run, the cost of construction will be rising.3
Payrolls
On Friday, Non-Farm Payrolls (NFP) for January came in at +143K, lower than the consensus estimate of +175K.15 16 As we’ve noted in past blogs, the Bureau of Labor Statistics (BLS) adds a number to the NFP every month because their survey includes large and medium size businesses, but no small businesses. That number is supposed to account for small business growth. This is known as the Birth/Death Model, and in January’s data release, that add was +126K.22 23 On net, then, the actual survey count was only +17K (126K+17K = +143K). Also of note, the U3 Unemployment Rate fell from 4.1% in December to 4.0%.15 16 Yet despite this seeming strength, it appears that the labor market is actually softening. Such evidence includes:
- -0.3% fall in hours worked in January, the lowest number of hours worked since March, 2020;23
- The factory workweek declined by -0.2%;23
- The Index of Aggregate Hours Worked also declined -0.2% in January;23
- According to Rosenberg Research, the contraction in hours worked in December and January was the equivalent of -120K jobs for December and -230K for January;23
- Those working part-time but wanting full-time employment, known as Part-Time for Economic Reasons, rose by +119K in January;23
- Holders of multiple jobs rose by +286K in January, a sign of increasing economic stress;23
- The JOLTS (Job Openings and Labor Turnover Survey), which came out mid-week, showed a dramatic reduction in the hiring rate;5 22
- The annual revisions to the payroll data, which occur every February, put the number of jobs -610K lower as of December.14 24 That’s an average reduction of -51K/month.
All the above data leads us to conclude that the “strong” labor market is now showing weakening trends that are likely to have a negative impact in the near-term.
In addition, the latest University of Michigan Consumer Confidence Index retreated to a score of 67.8 in February, down from January’s 71.1 score. Of note, the Current Conditions sub-index got knocked for a loop, falling to a score of 68.7 in February from January’s 74.0, indicating a rising level of stress in the current environment.
Inflation and the Fed
Our past blogs have pointed out the lags in the data, especially rents, used by the BLS to calculate CPI inflation. In addition, the media is fixated on the year/year inflation rate. As of December, the official rate of CPI inflation was 2.9% (that’s a year/year calculation).17 25 26 But for the latest six months, it has fallen to +0.9% (Annual Rate) and to +0.4% for the last three months.25 26 Clearly, with falling rents, the monthly rate of inflation is now running well below the Fed’s 2% target. CPI for January is due on Wednesday, February 12th.20 That should provide further information for markets to digest. One note of caution: January often contains automatic annual price increases, especially on the services side (like insurance premiums).25 26 So, the downtrend in the CPI could be at risk. Nevertheless, we still think that the Fed will be lowering the Fed Funds Rate at a much faster pace than currently priced in the market.18 19 And that means that long-term rates, as represented by the 10-Year Treasury Yield, will be falling faster than markets now anticipate. Currently, odds of a rate cut in March are down to 8.5% (was 16% before the NFP number), and those odds were trimmed from 65% to 57% for the Fed’s June meetings.18 Our view is that those odds are way too low, especially in this year’s second half.
Final Thoughts
The DeepSeek AI model (AI may be much cheaper than assumed) injected more uncertainty into the equity markets, causing prices in certain segments of the tech sector to pause (and/or slightly retreat) over the two weeks ending on February 7th.1 7 10
Of course, the tariff issue, especially regarding Mexico and Canada, also played (and continues to play) a significant role in market sentiment.4 5 After all, markets abhor a high and rising level of uncertainty. Add to that the Monday (February 10th) announcement of 25% tariffs on imported steel and aluminum.4 20
The other big data announcement was the Payroll Survey (NFP) which reported +143K (lower than the market consensus of +175K).14 17 23 On Tuesday, February 4th, the JOLTS (Job Opening and Labor Turnover Survey) reported a marked decline in hiring rates.5 21 Overall, the data showed a reduction in the workweek and aggregate hours worked in January to the lowest level in nearly five years. In our view, the characterization of the labor market as “strong” by Fed Chair Powell, and by the media, is likely a significant overstatement.
The inflation news continues to be hopeful. While the Fed and the media are fixated on the year/year rate of CPI inflation (2.9%), the annualized rate over the past six months has fallen below +1% and to just +0.4% over the past three months.27 26 On a year/year basis (the one the Fed prefers), if recent inflation continues, the rate of CPI inflation is highly likely to be at or below the Fed’s 2% target by the end of June. In this scenario, interest rates will be falling, and the market odds of rate cuts will be rising.18 19
(Joshua Barone and Eugene Hoover contributed to this blog.)