Stocks had a mixed close on Friday in the wake of a super-hot inflation figure, good in the eyes of some investors, but not all investors. New hires for July nearly doubled what economists were expecting, not bad for a recession.
Working 5 to 9. We simply cannot avoid the discussion about the current labor market in the US. Let’s start at the top. Friday’s monthly employment situation for July came in not only strong, but rather, they came in hot, white hot. Economists were expecting the new Non-Farm Payrolls to come in at +250k, but there were actually +528k new jobs created. What’s more, June’s number was revised upward by some +26k. That supersized jump in new hires also came with an Unemployment Rate of 3.5%, lower than expected, but more importantly, at the multi-decade low achieved before the pandemic. If we simply ignored all the other economic data points and focused solely on labor, you would think that the US economy is running at a strong, expansionary pace. If you are an optimist, stop reading now – all is good. If you are a pessimist… well, you have some thinking to do here.
Employed people are generally confident and they have money to spend. Money to spend and confidence equates to demand…WHICH IS A KEY DRIVER OF INFLATION. Sorry, but it gets worse. The labor market is tight. We know this because earlier last week we learned that there is still a significant amount of unfilled job openings, 10.7 million to be exact. Demand for labor is high, and supply appears to be short. You see where this is going? High demand and low supply for labor push prices…or wages higher. That is good for workers but bad for companies…and you and me when we are concerned about inflation. Friday’s data series also featured average hourly earnings which came in higher than expected and got an upward revision for June. This serves as evidence of a hot labor market. Going back to why this is bad for you and me, when companies see rising costs, they pass those along to consumers in higher prices…aka inflation. Ok, but still, a strong labor market is good for the economy, isn't it?
The Fed is tasked with maintaining that elusive balance between a strong labor market and inflation. The central bank operates under its dual mandate of maintaining low inflation while maintaining low unemployment. If you agree with the former paragraph, you know how difficult it is to strike that balance. You also know that, at current, that relationship is far off balance. Inflation is hot and unemployment is low, some may argue that it is too low. Um, in fact, even the Fed thinks it’s too low. The Chairman, in his post-FMOC meeting presser, said that some health in the labor market must be sacrificed in order to bring prices back into check. He didn’t use those exact words, but what he implied was that the Fed would be willing to let the strong labor market deteriorate somewhat while it works to get inflation under control. Clearly that has not happened yet. The Fed has raised interest rates aggressively in the past several months going from 0 to 2.5% in almost record time. Many believe that these moves are sufficient and as the hikes work their way through the economy, inflation will ultimately fall back in line. That may be the case, but the Fed is far from backing away from its rate-hiking, according to the latest wave of Fed-speak. The market too has not let up on its projections for interest rates. In fact, on Friday, probabilities for a bigger September hike jumped. Going into Friday’s number, there was a 100% chance of a +50 basis-point bump with a 35% chance of an additional +25 basis-point increase. After the news hit, the probability for that additional +25 basis points jumped to 76%...pretty good odds.
This is where stock investors get a bit edgy. Much of the recent rally in stocks was driven by lower expectations of rate hikes in the future. With higher rates now being predicted by the market, does that spell bad news for the stock market? It should all come down to corporate financial health. Earnings season has shown us, to date, that companies are healthy and maintaining sales growth while continuing to increase margins. Will rising rates stop that train? Is good news for the economy bad news for stocks? Investors will vote on the answers to those very questions in the days to come. Are you confused yet? How about if I remind you the US is in a technical recession? The Consumer Price Index will be released later this week, and it has the potential to force that vote, if it doesn’t happen in the interim.
FRIDAY’S MARKETS
Stocks had a mixed close on Friday. Good news about the health of the economy was good for the cyclical-dominated Dow and economically sensitive small-caps of the Russell. Higher implied interest rates are a downer for the growth-dominated S&P and the Nasdaq. Don’t believe me? Read on. The S&P500 slipped by -0.16%, the Dow Jones Industrial Average gained +0.23%, the Nasdaq Composite Index lost -0.50%, and the Russell 2000 Index advanced by +0.81%. Bonds fell and 10-year Treasury note yields jumped by +13 basis points to 2.82%. Cryptos rallied by +3.82% and Bitcoin advanced by +2.10%.
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