Friday's jobs report raised both eyebrows and interest rates. Explore why strong employment numbers caused market volatility.
Check your gut at the door. If you missed it, Friday was a bit of a gut check for markets after the indexes dropped in response to a better-than-expected monthly jobs release. Let’s dig into this a bit this morning as we kick off an extremely important week of events that will be impactful on… er, your gut. We must start off with the Bureau of Labor Statistics’ employment situation release.
New Nonfarm Payrolls exceeded analyst estimates by quite a bit surely raising eyebrow number 1. Before I break it down, it is important to note that the prior month’s release was revised down, so technically, the leap was a smaller one than might appear on the surface. Looking across the aggregates, the largest gains came from Education and Health Services, and I am sure you won’t be surprised to learn that the bulk of those came from Health Care & Social Assistance. You know, the very same industry that is in the top two usual suspects in consumer inflation, so it should be noted that the already hot industry remains… well, hot from a jobs perspective. Manufacturing lost jobs for the month, topping off a challenging year. This should also not surprise you if you have been following the weak manufacturing PMI numbers in the past year. Ok, for the record, though I am sure that manufacturing may not interest you, it is a critical component of economic growth. Have a quick look at the chart to get an idea of the bigger picture.
This is a chart of Nonfarm Payrolls from 2022 through present. I have added a 12-month simple moving average (yellow line) so you can see the clear trend that followed the post-pandemic-lockdown hiring boom. Please also note, at a very high level, traders would look for prints above or below that line as an indicator. So, for example we just had two straight months of releases above the moving average, which could be interpreted as positive for hiring. “Wait,” your thinking, “is that a typo, did he just say positive?” Why, then did stocks get slapped so hard on Friday? Before I get into it, let’s talk about the Unemployment Rate.
The Unemployment Rate Came in at a lower-than-expected 4.1%. Now, on the surface this miss, and month-over-month decline may appear to be positive for the labor market, but if we just scratch the surface a tiny, teeny bit, we note that Job Leavers actually bumped higher, offsetting what was a weaker New Entrants category. Really, New Entrants are what we would like to see growing because it means… um, new hires. Ok, so what I am saying is that this was kind of a neutral print, but it still gets a raise of eyebrow number 2, bringing both eyebrows to a raised position due to the decline in the headline number.
Why two eyebrows up? Well, going back to the Fed’s dual mandate, healthy employment is one of those mandates. If the Fed was worried about a weakening employment environment, as it was when it began cutting rates in 2024, it would be inclined to lower them further. A strong print in the monthly series should take the pressure off the Fed and lower prospects of future cuts. The markets certainly interpreted the release as such. Fed Funds Futures quickly shifted 2025 projections to a single 25 basis-point cut from decent chances of two, prior to the release, which gave at least a 70% chance of a second cut. By this morning, futures are only giving 99% odds of one cut, though by Wall Street standards, that would be considered a done deal. Further evidence of the markets’ readjustment could be found in 2-year Treasury note yields which jumped by around 10 basis points in the wake of the announcement. Those yields are highly captive of Fed policy and attempt to predict overnight rates two years from now.
Moving further out on the yield curve to the benchmark 10-year Note, we saw yields jump by some 6 basis points in the session after the release. Now 10-year yields are in the hands of traders with minimal if not any Fed influence, so what happened there? Let’s start with the simple answer. Strong employment means more dollars in consumers pockets… you know, because they have jobs. 😉 It also means increased consumer sentiment… you know, because jobs are aplenty. More dollars and more confidence will lead to more consumption, more consumption leads to increased consumer demand, and increased demand for goods and services leads to… well, inflation! If traders are expecting more inflation, they require higher yields to compensate for expected, increased inflation. The net result is higher yields for longer-maturation, fixed income paper. A quick word on the not-so simple explanation. In the technical alter-universe, 4.75% would be a natural resistance point, being a round, psychological number. There was also another resistance point at 4.70%, not only because it is a round number, but it is also around the recent high close from April of last year. These resistance points also become targets for traders looking to “shake things up,” so to speak. And that they did on Friday.
So, we got some strong labor numbers which caused not just shorter-maturity yields to climb, but also longer-maturity ones as well. That became the cause for a selloff in stocks, but not just some, almost all. Now, here is where things get a little murky. We see that the Nasdaq Composite took a larger hit than the S&P500. The Nasdaq is typically associated with technology and growth stocks, which the S&P, though heavily weighted in those, is considered a broader representation. Disappointingly, one of my favorite journalists described it like “the interest-rate-sensitive, growth-heavy Nasdaq declined.” Now, I am not going to get on my soap box about this, but I have been writing a lot about this recently. I just want to state for the record that tech, or more broadly, growth stocks were not historically considered to be interest rate sensitive. Interest rate sensitive stocks are those that investors buy for yield, or those that rely heavily on debt finance to do what they do. So, in a general sense, those would be Utilities and Real Estate stocks.
Let me ask you a question. Do you own or do you fancy owning any of the Magnificent-7 stocks? What about any of those great tech stocks that are rapidly growing? Did you buy any of those stocks for their dividends? Alphabet pays a 0.41% dividend yield. Not too shabby, but if you are looking for income, Alphabet is not your stock. Alphabet has $93.2 billion in cash lying around. Do you think it needs to borrow money, being forced to accept these higher interest rates? The answers are NO and NO, unequivocally. But I do want to acknowledge, that interest rates theoretically affect all stock prices, no matter what sector the stock is in. Yes, I know that interest rates find there way into the denominator of the present value equation which makes theoretical present values of future cash flows go down as they go up, but folks… really? Will 10-year bond yields determine NVIDIA’s earnings growth in 3 years from now?
Finally, let’s take one big step back. Friday’s employment number was solid. Solid employment is the key ingredient for a growing economy. A growing economy! A growing economy is required for all companies to excel, no matter what sector they are in. So, yes, markets certainly gave us a gut check last Friday, but if we check our brains, we might find a little solace. If you are a long-term investor, you should be pleased with Friday’s employment number. Wednesday of this week will give us some more important numbers to contemplate. We have inflation figures, which will also impact interest rates. Wednesday also marks the unofficial-official start to earnings season. Those releases, THOSE, are the ones you should really concern yourself with. Forget the gut check, let’s have brain check, and stay focused on what is important.
FRIDAY’S MARKETS
Indexes tumbled on Friday after monthly labor numbers showed a greater-than-expected surge in new hires last month along with a drop in Unemployment Rates. Meanwhile consumer sentiment slipped from the prior month on lowered future expectations, according to the latest report from University of Michigan. Jobs data caused bond yields to lurch higher striking fear in traders who opted to opt out by selling interest-sensitive stocks.
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