KBRA Financial Intelligence

3 Things in Credit: Recession Probabilities, Additional Jobs Data, and Q3 Earnings

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

Alright, we are into October, in the homestretch to the election, so we’re supposed to be on the lookout for the October surprise. And no, I don’t think the Jets firing their coach qualifies (although that was a shocker). Back on the data front, interesting to hear Jamie Dimon tick off this week what he sees as unsettling sources of inflation: remilitarization, large fiscal deficit, energy transition, unfavorable demographics. Something to get your mind off of the implications of the election.

This week, our 3 Things are:

1. Recession probabilities. We’ll take a look globally as we enter the easing cycle in the West.

2. Jobs data. You know what the BLS says. Do you believe it?

3. Q3 earnings. We’ll take a look at what’s ahead.

Alright, let’s dig a bit deeper.

Recession probabilities.

As we continue on through our post-pandemic normalization, one thing is clear: recession probabilities are relatively low, having, for the most part, declined meaningfully over the past year among the major developed world economies.

We know the U.S. economic story has proven to be more resilient than what was expected a year ago, when stubborn inflation gave rise to a higher-for-longer rates framework from the Fed. A year ago, one-year consensus recession probabilities were 55%. Today, with core inflation down to 2.7%, the Fed moving to recalibrate restrictive rates lower, and still healthy levels of economic growth and employment, recession probability has dropped to 25%. For what it’s worth, Goldman Sachs has dropped their estimate to 15% on the back of the strong jobs report.

What’s been more surprising is developments in the eurozone, where recession probability has fallen from likely a year ago (65%) to not so likely (30%) today. This, despite the region’s largest economy, Germany, headed in the wrong direction, bouncing recently from 30% back up to 43%. The good news is that France, Italy, and Spain have stabilized on lower energy costs and the prospects of less restrictive interest rates. Clearly, the region’s long-term challenges remain, outlined so graphically in Mario Draghi’s recent report on European competitiveness. But for now, limping along beats the alternative.

Another better-than-feared surprise has taken place in the UK, where recession probability has fallen into line with most other developed world jurisdictions at 30%. That was 63% a year ago. And it’s interesting to hear Labour talking about improving productivity and the efficiency of capital markets.

In Asia, recession probabilities are low, something to be expected in these typically statist economies. China and Japan are currently running at 15% and 30%, respectively. The bigger stories, of course, are just how much growth either economy can generate. China, of course, is the greater wild card here, with the fundamental restructuring of its economy presenting risks to the downside.

Still, safe to say, we are on improved economic footing from where we were a year ago. All of the G7 are forecast to grow over the full course of 2025, anywhere between 0.9% (Germany) to 1.8% (U.S. and Canada). And those forecasts are, as we are fond of saying, “good enough for credit.”

Alright, on to our second Thing—Additional Jobs data.

The latest out of the Bureau of Labor Statistics blew away every estimate and ran solidly counter to Jay Powell’s cautionary words (and deeds) at the last FOMC.

The economy added 254,000 jobs (well above the break-even rate of around 165,000 or so). The unemployment rate was two ticks away from 4%, effectively reversing the Sahm Rule, and well under the 6.2% 50-year average. The previous month was revised higher by a not insignificant 72,000. By all accounts, this is full employment.

But something doesn’t feel right. The hiring rate is at a 10-year low. Hours worked are the lowest since the pandemic began. The employment elements in both the ISM services and manufacturing surveys are solidly in contraction territory. In the latest report, cyclical industries—transports, manufacturing, and banking—showed job losses. Oh, and then there are the revisions: July’s and August’s result up by a combined 72,000, June’s down by 61,000. And don’t get us started on the 818,000 revision lower to the year ended March 31. What gives?

We have long questioned the quality of the data out of the BLS. We find the two surveys unnecessarily confusing, and we wonder about response rates. We question the modeled output of the Net Birth-Death adjustment. So naturally, an op-ed in The Wall Street Journal the day before the jobs release titled “Can We Still Trust the Unemployment Rate?” caught our attention. The piece was authored by two former commissioners of the BLS, William Beach, who served from 2019-23, and Erica Groshen, who served from 2013-17.

The authors aren’t hung up on methodology. They’re hung up on money; as in, there isn’t enough to produce a quality report. They contend that the BLS has been underfunded for more than a decade. This has prevented the agency from adapting their data collection processes to the web. To quote the former commissioners, “If Congress doesn’t invest now in a web-based, adequately sized survey, it risks a snowball effect in which Current Population Survey responses and their usefulness continue to decline.”

So, what to do with all of this? There aren’t useful alternatives, so it is what it is. I guess the moral of this story is, don’t lose sight of the other bits of reporting out there (such as the JOLTS report), and if something seems too good (or bad) to be true, it often is. That helps to put shock releases like July’s low 114,000 jobs or September’s high 254,000 in better, less manic, perspective.

Alright, on to our third Thing—Q3 earnings.

We’ve spent a bit of time recently talking about the outright bullish consensus forecast for 2025: 15% EPS growth year-on-year for the S&P 500, according to FactSet. That’s a long way from the earnings recession we had from Q4 2022 to Q2 2023, when the effects of the inflation surge were being felt and when the Fed was at peak hawkishness. Earnings growth has been on an upswing ever since, reaching 13% year-on-year in Q2, driven by a more durable than expected consumer that has allowed businesses to achieve higher operating leverage and, ultimately, higher margins.

Q3 2024 EPS is expected to come in at a more sobering 4.2% for the S&P on sales growth of 4.7%. Eight of the 11 S&P sectors are expected to show earnings increases, three by double digits: information technology (15%), health care (11%), and communication services (11%). The three sectors expected to report decreases are led by energy (-21%), materials (-3%), and financials (-0.4%).

On a more ominous note, nine of the 11 sectors saw their estimates fall over the course of the quarter, led, not surprisingly, by the commodity sectors, energy and materials, which came down 19% and 9%, respectively. Industrials also saw its estimates come down 9%. All of that is consistent with an expectation for a slowing economy, especially on the goods-producing side of things. Overall, estimates came down 4% over the course of the quarter.

As we have mentioned previously, growing earnings 15% into a slowing economy expected in 2025 strikes us as incongruous. Remember, economic growth in the U.S. is expected to fall in 2025 to 1.8% from 2.6% in 2024, as the effects of stimulus finally wear off and we get back to a more normal steady economic state. Now, to be fair, the Atlanta Fed GDPNow estimate for Q3 is running north of 3%, so the trend is clearly our friend. Let’s see how long it lasts.

So, there you have it, 3 Things in Credit:

1. Recession probabilities. We’re moving in right direction for the most part.

2. Jobs data. It is what it is, but don’t lose sight of other relevant measures.

3. Q3 earnings. A more sobering outcome is forecast, but Q2 outperformed, and ex-commodities, what’s really changed? The real test is 2025.

As always, thanks for joining. We’ll see you next week.