Private sector jobs are still growing

The headline jobs numbers were disappointing on the surface (+29K actual vs +90K expected). But one month's worth of data is not enough to know what the underlying trend is—jobs are notoriously volatile from month to month. I prefer to look at the 6- and 12-month growth rates of private sector jobs; those are the ones that matter. Government jobs have been stagnant for the past six months, and are down 1% over the past year. Flat to down government jobs are actually something to cheer about.

Chart #1

As Chart #1 shows, private sector jobs growth has actually been improving since earlier this year.

However, the rate of improvement is still quite modest, and hardly enough to warrant or justify another Fed rate hike at the next FOMC meeting in late October. 

Jobs growth update: modest improvement in August.

Private sector job growth (the only jobs that really count) exceeded expectations in August (+127K vs +50K), but the overall picture remains the same: jobs growth over the past year or two has been very weak, but it has been improving over the course of the past year. The economy has regained its footing after the illegal-immigrant crackdown and the turmoil induced by Trump's tariffs and the war in Iran. 

To judge by today's reaction to the news, the bond market thinks that today's upside jobs surprise increases the chances of a Fed rate hike at the next FOMC meeting (September 16) from 50% to 60%. I disagree. If anything, I would argue that jobs growth remains so weak that a rate hike might pose a threat to the economy. Recall that two years ago the Fed began a series of six rate cuts which ended last December. That was likely the catalyst that arrested the decline in jobs growth which began in early 2022. Also recall that there is a "long and variable lag" between monetary policy changes and their impact on the economy.  

Nevertheless, jobs growth these days pales in importance compared to the rate of inflation. Expectations for next Friday's CPI report call for little or no change from last month's 3.4% y/y for total, and 2.4% for core—both currently running at only slightly more than Warsh's target. Meanwhile, the housing market continues to suffer from very slow sales growth, weak residential construction, elevated mortgage rates, and flat to falling home prices. These latter factors are likely to act as a continued headwind to the government's CPI calculation, as they have been doing for the past several years.

It's a good thing that Fed Chair Kevin Warsh is hyper-focused on reigning in inflation, but I don't think he will interpret these developments as a reason to raise rates any time soon. 

Chart #1

Chart #1 compares the level of private and public sector jobs. Of note, private sector jobs growth has been tepid in recent years, while public sector jobs—particularly at the federal level—have suffered a significant decline, thanks to Trump’s efforts to trim the federal workforce, which has shrunk by almost 2.7 million on his watch and hasn't been this small since 1966! 

Chart #2

Chart #2 compares the growth rate of private sector jobs, measured on a 6-month annualized and a year over year basis. (Doing this is essential to filter out the notorious “noise” in the monthly data.) It is becoming clear that the economy's vitality reached a low ebb in late 2025 and has since begun to recover. 

A Goldilocks economy?

When I review recent news and ponder the meaning of the charts below, these are the thoughts that come to mind:

The M2 money supply is well-behaved—the excesses of the Covid era have been absorbed—and it is once again growing at a rate that in the past has been consistent with relatively low inflation. Interest rates at current levels (5-yr Treasury yield ~4.5%, 10-yr ~4.7%) seem about right given a relatively slow-growing economy and inflation of 2-3%. Corporate profits are on the moon—literally off the charts. Stocks are fairly valued, maybe a bit rich, given the current level of interest rates. Unemployment is low and falling. Jobs growth is slow (1.5-2%) but increasing. The Fed is not making any big mistakes. Woke energy policies are fading fast, even in Europe, and AI is spreading like wildfire. Global economies are thus likely to enjoy a tailwind for the foreseeable future. Is this a Goldilocks economy, or what?

Chart #1

Chart #1 compares the level of 5-yr Treasury yields to the ex-energy rate of inflation. (Energy is by far the largest contributor to the ups and downs of inflation, and the war in Iran has only made matters worse.) Interest rates at current levels have kept inflation in check in the past, and now seem likely to exert a bit of down pressure on inflation going forward. Regardless, I continue to believe that the inflation statistics overweight and over-measure shelter costs, and that problem is slowly receding.  

Chart #2

Chart #2 shows the level of the M2 money supply plotted on a logarithmic scale to highlight its fairly constant growth rate over time. M2 grew by about 6% a year from 1995 through 2007, and during that time inflation was relatively low and stable. Today, M2 is only slightly above its long-term trend. 

Chart #3

Very few analysts track the relationship of M2 to nominal GDP. I think it is a good measure of the demand for money, and that is key to being able to understand whether the Fed is doing its job with the money supply. (Inflation happens when the supply of money exceeds the demand for it.) Money demand is back to where it was prior to the Covid era. Coupled with the 6% growth rate of the M2 money supply, this leads me to the conclusion that monetary policy likely is in a sweet spot for now. (Long-time readers will know I have been saying this for the past several years.)

Chart #4

Chart #4 shows the ratio of economy-wide corporate profits (a key component of the GDP accounts) to nominal GDP. Think of this as a proxy for corporate profit margins. Corporate profits are at historically high levels, and more than twice what they were in the 1970s and 1980s, as the dashed green lines show. No economist in his right mind would ever have predicted this, and I certainly didn't. With corporate profits at record levels and growing, is it any wonder that the stock market is making new highs?

Chart #5

Chart #5 shows the level of the S&P 500 index plotted on a logarithmic scale. The green line is a stand-in for the long-term growth trend of this index (~8% per year). Pay particular attention to the 2008-2009 recession, and how this resulted in a severely depressed stock market. Now note that the S&P 500 has come back to its long-term growth trend; this is why stocks have had such a strong run over the past 17 years.

Chart #6

The red line in Chart #6 compares the actual market capitalization of the U.S. stock market using the S&P 500 index as a proxy, while the blue line is the result of capitalizing the measure of corporate profits that I have used in preceding charts. To capitalize profits I divide corporate profits by the 10-yr Treasury yield)*. Note that the market cap was significantly lower than capitalized profits from 2009 through 2024; this corresponds to an underperformance relative to trend from 2009 through 2024 that shows up in Chart #5. It is certainly likely that the undervaluation of stocks during that period was exaggerated by the fact that the Fed was mistakenly keeping interest rates historically low for a number of years.

None of this is science, to be sure, but from two different perspectives it seems that as of a few years ago, stocks have returned to prior trends and are now more or less fairly valued. This could of course change if the Fed were to significantly raise interest rates, since that would reduce capitalized profits and in turn depress stock prices.

* Reasonable people could argue about which yield to use when capitalizing profits, but I think the 10-yr Treasury yield is as good as any. I credit Art Laffer with bringing this method of equity valuation to my attention many years ago: he used it in early 2000 to correctly argue that stocks were overvalued and due for a fall.

UPDATE: (Aug 28 '26): 

Chart #7

Chart #7 is Bloomberg's Financial Conditions Index, which tracks just about everything you would want to know about financial conditions. The latest reading is just shy of a multi-year high, which is exactly what you might expect to see in a Goldilocks economy.