Knockout July jobs report boosts rate hike probability
ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKETS COMMENTARY — August 8, 2022
Stocks were mostly higher last week. However, Friday’s unexpectedly strong July nonfarm payrolls report poured cold water on the idea that the Federal Reserve is ready to slow the pace of rate hikes at its September meeting. A building market assumption that relief from aggressive Fed actions could come as soon as next month has been a contributing factor to helping stocks climb higher from their mid-June lows.
But after Friday’s employment report showed the U.S. economy created over a half million new jobs in July, odds of a 75-basis point hike at the Fed’s September meeting jumped to 67% from 33% the previous day, according to CME FedWatch, as of August 5. The Federal Reserve has lifted its fed funds target rate by 75 basis points at each of its last two meetings. Before its late September meeting, the Fed will receive another update on employment and see two Consumer Price Index (CPI) reports.
On the week, the S&P 500 Index rose +0.4%, while the NASDAQ Composite finished higher by +2.2%. Notably, the S&P 500 ended the week slightly positive, despite falling in four out of five sessions. Major U.S. averages were led higher last week by Information Technology (+2.0%) and Consumer Discretionary (+1.2%) but weighed down by Energy (down 6.8%) and Real Estate (down 1.3%). The Dow Jones Industrials Average finished the week essentially flat.
The direction of the 10-year U.S. Treasury yield was particularly volatile last week, as the yield dipped to as low as 2.50% on Tuesday before jumping to 2.84% by the end of the week. The 2-year/10-year U.S. Treasury yield spread continued to dip further into negative territory, hitting its widest inversion since 2000. Bottom line: The Treasury curve continues to flatten, and in some cases, inversions across the curve (i.e., when shorter duration rates yield more than longer duration rates) are flashing a greater probability of a U.S. recession over the coming quarters.
U.S. dollar and gold up; Oil down on the week
The U.S. dollar strengthened against a basket of currencies last week, Gold rose +0.5% to $1790.40 per ounce, and West Texas Intermediate crude fell 9.7% to below $90 per barrel. By Wednesday, U.S. gas prices had dropped for the 50th straight day, off nearly 20% from the mid-June peak. At the week's close, the AAA national average price for a gallon of regular unleaded gasoline stood at $4.08, down from $5.02 on June 14th but still higher than the $3.19 average one year ago. Helping to curb gasoline prices over the last month or so has been the steep drop in WTI crude prices. At below $90 per barrel currently, WTI is well off its peak of over $130 in March — and sits at a level not seen since before Russia invaded Ukraine. Falling gasoline prices in July could help relieve some upward inflation pressure on this week’s July CPI report, a significant item of investor focus during the week ahead.
More on that jobs report; CPI ahead
Leading into this week’s highly anticipated CPI update was last week’s July nonfarm payrolls report that pushed back on the narrative that the U.S. economy is in or on the brink of a recession. The U.S. economy added +528,000 new jobs last month, faster than the +250,000 jobs forecast and well-above June’s upwardly revised +398,000 pace. The increase in new jobs last month was the fastest pace since February, with broad job gains seen in leisure, hospitality, healthcare, and professional/business services. Notably, U.S. employment has returned to February 2020 levels, with the economy recovering all the jobs lost during the depth of the pandemic.
In addition, the unemployment rate fell to 3.5% in July, also returning to pre-pandemic levels. However, average hourly earnings came in hotter-than-expected last month, indicating inflation pressures have not abated given the tight labor market. While investors’ reaction to the July employment report was rather negative last Friday due to its implications for monetary policy, we would argue that a strong labor market remains a bright spot for the U.S. economy.
In our view, if consumers in aggregate do not feel threatened they are in immediate danger of losing their job, they are unlikely to materially curb spending overall. And while elevated inflation pressures should continue to crimp spending and shift where dollars are spent, we believe a broader reduction in consumer spending is less likely as long as the job market remains healthy.
With that said, one area to keep a watchful eye on is the trend in weekly initial jobless claims. Last week, initial jobless claims ticked up to 260,000, up from its April trough and back near November levels. Importantly, weekly jobless claims provide a more up-to-date health assessment of the U.S. labor market. At the same time, the nonfarm payrolls report acts with a lag and is less effective in providing predictive power on the state of labor conditions.
Nevertheless, weekly unemployment claims remain relatively low historically, and job growth in the U.S. remains robust. In our view, it is tough to argue the U.S. economy is in or on the brink of recession, given the latest updates on employment. This is one reason the market is now beginning to more fully price a 75-basis point hike in rates next month from the Federal Reserve, as the strength in the labor market can likely absorb
further rate increases.
Looking ahead to this week’s CPI report on Wednesday, FactSet estimates call for the headline Consumer Price Index to rise +8.8% y/y in July, down from the high-water mark of +9.1% in June. July CPI (ex-food and energy) is expected to rise to +6.1% y/y from the +5.9% pace seen in the prior month. Declining gasoline prices in July should help lower the headline figure, though most expect food prices to have remained elevated last month. Notably, core inflation is expected to remain firm as continued upside pressures in housing subcomponents, such as homeowner's equivalent rent, could act to counter other components that see price pressures moderate. And while core goods inflation could remain elevated in July, falling import prices, rising retail inventories, and negative year-over-year comparisons could help bring core inflation down as the year progresses.
Other economic items of note during the week include Tuesday’s update on the July NFIB Small Business Index, the July Producer Price Index on Thursday, and a preliminary look at August Michigan Sentiment on Friday. While Michigan sentiment is expected to tick higher from July levels, the report will be watched mainly for its forecasts on inflation. While consumers in the survey see near-term inflation as very elevated, their assessment of longer-term inflation has been more sanguine. For the market, and even the Fed, the inflation component inside the Michigan Sentiment survey provides a critical update on determining if longer-term inflation expectations are becoming entrenched or not.
Coming up: Q2 earnings comes to a close; Close watch on China; Dems’ bill heads to the House
On the corporate front, Q2 earnings reports will slow to a trickle this week, with 23 S&P 500 companies reporting results. With 87% of S&P 500 Q2 reports complete, the blended earnings per share (EPS) growth rate stands at +6.7% year-over-year on sales growth of +13.6%. While the most recent earnings season has seen fewer S&P 500 companies surpassing analyst estimates compared to the longer-term average, Q2’22 EPS growth has come in better than the +4.0% y/y rate expected at the end of June. Notably, Q3 and Q4 EPS estimates have decreased considerably since the end of June, given current demand and inflation headwinds. However, earnings growth is expected to remain firmly positive for the second half, offering investors a still optimistic profit backdrop and companies a lower bar to hurdle over when they report results.
In the background this week, investors will likely continue to monitor U.S./China tensions over Taiwan as well as the final stages of Democrats’ roughly $740 billion Inflation Reduction Act of 2022. The bill expands credits for the manufacturing/purchase of electric vehicles, provides rebates for energy-efficient appliances, includes funding for drought and climate initiatives, has drug price reform embedded, and cuts the deficit. To help pay for the bill, companies making at least $1 billion would be required to pay a minimum 15% corporate tax, including an excise tax on stock buybacks for large companies. Thus far, the market has looked past the potential marginal headwinds the bill could create for corporate America. Over the weekend, the Senate passed the legislation along party lines and included some last-minute exemptions for businesses owned by private equity groups. The bill is expected to pass the House of Representatives this week before heading to President Biden’s desk to be signed into law.
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. The are not affiliated with Ameriprise Financial, Inc.
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