Financial markets experienced a roller-coaster ride last week as worries loomed over the upcoming employment report. However, the market breathed a sigh of relief on Friday with the release of a "strong" employment report, causing a reversal of some of the week's losses. Despite this, both the equity and fixed income markets ended the week showing lower prices.

The Dow Jones Industrials underperformed, possibly indicating the market's growing awareness of the issues plaguing the manufacturing sector, which have been alluded to for several months. A chart comparing Non-Farm Payrolls (NFP) and the Quarterly Census of Employment and Wages (QCEW) reveals a significant divergence since March 2022, with NFP showing five million more jobs. This raises concerns as the Bureau of Labor Statistics (BLS) has revised its initial number downward 11 times in 2023.

The Birth/Death (B/D) model, a number used to compensate for the long-term growth of small businesses not captured in the NFP survey, added nearly half of the NFP jobs during the February 2022 to February 2023 period, according to Rosenberg Research. However, new business "births" were down 4.4% during that time, while business "deaths" rose by 24.1%, casting doubt on the accuracy of the lower +130K monthly job growth estimate from QCEW.

Furthermore, discrepancies between NFP and the data from the Household Survey have been evident, with negative job growth reported in 2024. Examining QCEW data closely reveals a decline of 284,000 full-time jobs and an increase of 921,000 part-time jobs for the year ending in February. Rosenberg Research suggests an even more alarming decline of 1.3 million full-time jobs over the past year, emphasizing the negative implications of these numbers.

The brewing crisis in commercial real estate (CRE) is adding to the market's concerns. Leveraged loan delinquencies now exceed 6%, approaching levels seen in previous recessions. Office vacancies are at record highs, and CRE prices are plummeting, with 29% of all CRE and 56% of office loans in negative equity, according to Rosenberg Research. The pace of CRE foreclosures is accelerating, with significant foreclosures occurring almost daily as we enter the second quarter.

Given that banks hold half of CRE debt, it is expected that loan loss reserves will rise, potentially impacting bank earnings and capital. In previous banking crises, the Federal Reserve has opened special lending facilities to provide liquidity and stabilize financial markets. Nevertheless, as the CRE crisis spreads, a recession appears inevitable.

On the monetary policy front, Federal Reserve Chair Powell has reiterated the possibility of rate cuts, but market odds of a rate cut during the May meeting are minuscule, and June stands at only 50.8%. Full-time job contractions, weak existing home sales, stagnant industrial production, and real retail sales have led some to believe that lowering rates sooner rather than later would be advisable.

Amidst concerns over employment report discrepancies and the impending commercial real estate crisis, the Federal Reserve's stance on inflation remains a key factor. The trajectory of interest rates has been upward, with the 10-Year Treasury yield rising from an interim low of 3.79% in December 2023 to 4.38% in early April 2024. The next Consumer Price Index (CPI) release on April 10th will be closely watched, although the lagged rent data used in the CPI calculation suggests a neutral to negative impact on CPI inflation.

As the markets grapple with these uncertainties, the need for clarity and effective policy responses becomes increasingly apparent. The reliability of current employment report methods and concerns over potential manipulation require further scrutiny, while the brewing commercial real estate crisis poses risks to the banking system. All eyes remain on the Federal Reserve as both investors and economists await their decision-making in the face of these mounting challenges.