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Stocks gained on Friday with the stronger-than-expected jobs number, an indicator that the US economy is healthy. Friday’s strong showing leaves bond and stock traders in flux, wondering what it all means – is it good or bad?
Erasable ink. When I was young, we had several ways of getting an idea on paper. We had choices. One could use an ink/fountain pen, a ballpoint pen, or a pencil. By the time I was in the first grade, I think it safe to assume that feather quills were a thing of the past, leaving just two options. Pencils were the choice of most schoolchildren because they were erasable, a feature that was important for neophyte writers. As we progressed through primary school, ballpoint pens were introduced. After all, we were experts in print, cursive (also a thing of the past), spelling, and basic arithmetic by the fourth grade, right? That was a joke on so many levels. Of course, we weren’t. If one was so bold as to turn in an essay with a crossed-out word, a red mark in the margin was surely expected. If we found a mistake in proofreading, there was only one choice: rewrite the whole thing… neatly. But then, it happened. First there was fire, then the wheel, the discovery that the earth was round… and then in 1979 Paper Mate released its Erasermate, the first erasable ballpoint pen. It was a gamechanger! With it, one could simply write freely. Free to change one’s mind, mid-sentence. Take risky guesses on spelling. No problem, just erase and keep going. There would be no more sore-bottomed geese; the quill was officially retired.
Just last week in an interview with Bill Peters of Dow Jones MarketWatch, I told him that the big sea change of last quarter was a shift in focus from Fed rate cuts to fear of a slowing in the economy. It was, in essence, a shift from bad is good to bad is bad. The Fed set its path in stone, shifting from dovish overtures to dovish rate cuts when it shifted policy in its last FOMC meeting. The question then shifted to whether it was enough or too late to prevent an economic disaster, a recession, a not-soft… er, hard landing. Bill’s article was released yesterday. Check it out HERE. Between the time when he interviewed me last Wednesday and Friday’s close, something happened.
Last week was “jobs” week, which featured JOLTS Job Openings, a recently popularized number that details job vacancies, ADP Employment Change, a private estimate on new job creation for the month, weekly Initial Jobless Claims, and it all culminated in the monthly, “official” employment situation from the Bureau of Labor Statistics. The ADP figure beat estimates and was higher than the prior month’s reading, indicating a stronger labor market, and hinting that Friday’s number may surprise on the upside, though, historically, the former is not a good leading indicator of the latter. Despite this, stocks climbed somewhat on Wednesday. The news was met with a different sentiment in the bond market. Treasury Note yields climbed with Wednesday’s release.
At the front of the curve, 2-year Note yields gained, and at the back end, 10-year yields climbed as well, both for different reasons. The moves were subtle but noticeable, but the real big moves came on Friday in response to Nonfarm Payrolls, which not only significantly beat estimates, but also came with an upward revision to the prior month’s release. Additionally, the Unemployment Rate, which was expected to remain the same, declined to 4.1% from 4.2%. In the minutes after the 8:30 AM Wall Street Time release, I sent out a brief market summary to the press that included the following quote:
This morning’s release shows a healthier than expected labor market which increases the chances for a so-called "soft landing,” and will likely be viewed as positive by equity markets. The strong figure also increases the chances that the Fed’s next rate cut will be more in line with a traditional -25 basis-point cut, followed by another -25 basis-point cut before yearend.
Indeed, the equity markets did respond positively to the news of a healthy labor market. This was in line with the comments I made to Bill Peters earlier in the week. Stocks reacted as expected. Bonds, on the other hand made some interesting moves in response to the revelations. 2-Year Treasury Note yields jumped by almost a ¼ point! That is huge for short maturity notes. That was simply bond traders quite literally factoring out one -25 basis-point rate cut in the future. That sentiment was expressed in Fed Funds futures as well, the probability of a -50 basis-point move in November went to almost 0%.
10-year Treasury Note yields climbed as well, adding 12 basis points in response to the release. The gain in yield on the 10-year notes had nothing to do with the Fed, however. No, a strong economy increases the probability of inflation. Bond investors need more yield to compensate for inflation! Additionally, investors who were piled into Treasuries worried about economic catastrophe, abandoned their hedges, selling bonds and rushing back into risk assets, aka: stocks.
If you have been following me on these moves in yields, you may have also come to the conclusion that the yield curve flattened and is, this morning, slightly inverted, once again. This is a sign of a tight monetary policy and possible economic strife. Now that the economy seems stronger than expected, will inflation pick up once again? Will the Fed cut interest rates by less than expected, or worse yet, pause rate cuts? Has focus now shifted back away from the economy back to fear of what the Fed may do or not do next?
The ink on that MarketWatch has barely even dried, and we are already considering alternative hypotheses on the market. Be that as it may, the coming week will be packed with information that will answer these questions. We will get inflation figures later in the week, with any upward surprises sure to disappoint equity markets. Earnings season will also begin in earnest later in the week with negative surprises… well, they will not be received positively. Seems like the Erasermate pen will come in handy this week… and in the weeks to come. Finally, I have to credit the Paper Mate for heralding my official switch from ambidextrous writing, which I did up until high school, to right-hand-writing. I found that when I wrote with my left hand, most of the erasable ink was either smudged or missing by the time I got to the middle of a page. In some cases, that unadvertised feature may have come in handy, like last week.
FRIDAY’S MARKETS
NEXT UP
- No economic releases today, but we will hear from the following Fed speakers: Bowman, Kashkari, Bostic, and Bowman. You can count on their weighing in on last Friday’s numbers.
- Later in the week, we will get FOMC Meeting Minutes, Consumer Price Index / CPI, Producer Price Index / PPI, and University of Michigan Sentiment. Friday marks the official earnings season with a few early birds releasing prior. Download your weekly economic and earnings calendars, attached, to get ahead of the curve.
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