Soft Patch? Economy Looks More Like It's In For Worse

If this is what a soft patch in the economy looks like, then beware the specter of a hard landing.

New York Stock Exchange trader
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New York Stock Exchange trader

Perhaps no other profession is as fond of cliches, catch phrases and buzzwords than economics—"green shoots" to describe the first positive signs after the financial crisis; "transitory" for the surge in commodity prices over the past two years; and now "soft patch," the euphemism for the current economic downturn. (And we all remember "irrational exuberance.")

But with the release of Friday's unemployment numbers—coming on the heels of a clear double-dip in housing and prevailing weakness in manufacturing—the soft patch is becoming a hard sell.

"There really was no good news in this report," said Kathy Jones, fixed income strategist at Charles Schwab in San Francisco. "Even after ratcheting down expectations, this is a weak number...Even if this is not a new trend in terms of really super-weak numbers, this is nowhere near the kind of (growth) we need to see."

The economic trends are influencing investment choices down the line, with stocks no longer getting a buy-the-dips benefit and Treasury yields falling to fresh lowsas investors flee riskier assets.

Jones said her firm is sticking with Treasurys even with such low yields because of their traditional inverse correlation with equities. She said Schwab also is trimming back on exposure to high-yield and credit-sensitive areas.

It would be hard to overstate how bad the nonfarm payrolls report was, especially considering how it compares with where the economy should be at this point in a recovery. The gain in jobs of a much less-than-expected 54,000 and the increase of the unemployment rate to 9.1 percent only tells part of the story.

The increase was actually a net negative after subtracting the 62,000 positions fast-food giant from McDonald's, a spree that apparently didn't help the food service industry, which only created a net 14,000 jobs.

And the total number looks even worse when including the jobs created through the government's birth-death model—an abstract computation that seeks to approximate how many businesses were added and lost during the month. The birth-death model estimated an addition of 206,000 positions.

On a nonadjusted basis, the economy created 480,000 fewer jobs than in April.

The number of long-term unemployed—without jobs for 27 weeks or more—jumped to 6.2 million, while the average duration rose to a record high 39.7 weeks.

Yet the cliches kept on coming.

"While the report confirms the economy has entered a bit of a soft patch, we suspect this will prove transitory," David Resler, chief economist at Nomura Securities, wrote in a note to clients that included two of Fed Chairman Ben Bernanke's favorite expressions,

Trying to figure out how to play the labor market shock wasn't hard—traders sold stocks and bought Treasurys, particularly the 10-year note.

But all things considered, the stock selloff could have been worse. The market opened at its worst level of the day and then actually traded upward from that point, suggesting that a good portion of the jobs downturn had been priced in already, particularly in the steep drop after Wednesday's ADP survey correctly predicted an awful Labor Department report.

"Given the selloff Wednesday that's probably just some bargain hunters coming in (Friday) and saying it's a little overdone, let's buy things up," said Rick Bensignor, chief market strategist at Dahlman Rose in New York. "You'll still probably be wanting to sell into rallies."

Strategists are widely expecting a choppy market through the summer as the notion crystallizes that the economy cannot stage a real recoverywithout jobs and housing.

"While we agree that many of the shocks to the economy—gasoline prices, supply-chain disruptions—are temporary, the hit to confidence could linger," Bank of America Merrill Lynch economists told clients in a research note. "And today the big risk is a fiscal accident: too much short-term spending reductions in exchange for an increase in the debt limit, derailing the recovery. This kind of event will almost surely make this summer worse than last year's."

That sentiment reflected a piling on around the economics community regarding the suddenly shoddy state of affairs for the US recovery picture.

University of Maryland economist Peter Morici pointed out at that the economy needs to create 365,000 jobs a month to cut unemployment to 6 percent in three years. Christine Owens, executive director at the National Employment Labor Project, reminded that with 1.8 million jobs created since 2010 and nearly 8.7 million jobs lost during the recession, there is still a deficit of 6.9 million jobs, not counting the 4.1 million needed to keep up with population growth.

And Kathy Bostjancic, the Conference Board's director of macroeconomic analysis, pointed out that constrained consumer spending is limiting growth in the core services sectors.

"Employers spent a great deal of time and attention reducing costs over the past few years and are reluctant to add to their cost structure unless they can be certain the economy will not hit a soft patch," she said. "This degree of caution could remain in evidence right through Labor Day."