- The US economy added 528,000 jobs in July, the Labor Department said Friday.
- This signals that the labor market remains in good shape and the Fed can proceed with hawkish policies.
- This is bad news for equities, many on Wall Street said Friday.
On Tuesday, San Francisco Fed President Mary Daly broadcast a live stream on LinkedIn with CNBC’s Jon Fortt and sent a firm message: The central bank has “nowhere near” a tightening policy.
Daly’s frankness was very deliberate, some say. The Fed pulled out one of his most famous doves to return to what many investors had perceived as Jerome Powell’s washed-out comments at the July Federal Open Market Committee meeting the week before.
Markets were starting to question the Fed’s determination to tighten and were sniffing a pivot forward. Equities have continued to rally since mid-June.
With Daly’s appearance, “they’re telegraphing to the market, essentially recalculating,” said Quincy Krosby, chief global strategist at LPL Financial.
Daly’s comments were followed by similar statements from other Fed presidents, including Charles Evans, Loretta Mester, and James Bullard in what was seen as a coordinated effort to dispel any notion that the Fed was ready to fly with a branch. olive tree for investors.
Early Friday morning before the market opened, the dovish pivot narrative was completely shattered when the Department of Labor announced a monstrous report on the job. The United States had added another 528,000 jobs in July, they said, more than double the expected number.
A strong employment report is generally positive for the economy. More jobs mean the economy is in a healthy place: when people have jobs, they spend money and that supports companies’ earnings.
But with inflation at a 41-year high of 9.1%, markets have seen the strong labor market through an at least partially negative lens. The Fed has been fighting inflation aggressively by raising interest rates at the fastest pace since 1994 and reducing the amount of assets they hold.
A tight labor market is likely to continue to fuel demand and hence inflationary pressures. It also signals to the Fed that they are not yet creating damage to the labor market with their hawkish policies, so they can proceed as before without caution.
Eventually, hawkish politics is bound to catch up with the economy and therefore with stocks. Furthermore, the depletion of liquidity in the financial system thanks to the Fed tightening is not good for risky assets such as stocks.
This is why the market fell on Friday morning in reaction to the employment report. And more downsides are on the way, say many on Wall Street.
Because the shares “are not out of danger yet”
Steve Sosnick, Interactive Brokers chief strategist, said he expects the S&P 500 to drop and re-examine June lows of around 3,666, 11% from current levels of around 4,130.
Sosnick said the short-term bond market volatility that followed since June tells him that a further downside is on the way for equities, which have been strong over the same period.
“If the bond market fails to reach a consensus on short-term rates, how can the stock market be so sure of changing its consensus,” he said, arguing that bond traders have a much “purer” view of where monetary policy is directed with respect to stock traders. “If risk-free assets are volatile, how can we not expect volatility in risky assets, such as stocks,” Sosnick said. “These are the messages that the bond market is screaming at us.”
Krosby also said he sees an up to 10% drop in the S&P 500. John Lynch, CIO of Comerica Wealth Management, said more sales are on the way and the Fed is more likely to hike rates by 75 basis points in the meeting. in September, which would be their third consecutive excursion of that size.
“The wage growth is alarming for Fed officials, likely putting 75 basis points back on the table for the September meeting. Fed funds futures are already rising,” Lynch said in a statement Friday. “We believe this development signals the end of the recent bear market rally.”
Matt Peron, research director at Janus Henderson, also echoed these sentiments, saying that the actions “are not out of the woods yet.”
The severity of a potential sell-off appears to hinge on the rapid cooling of inflation or the ability of the US economy to fight a recession in the face of the most aggressive environment of recent decades. Or, if a recession cannot be avoided, how mild it is.
Jason English, an analyst at Goldman Sachs, said in a webinar last week that the United States is in a unique position to fight a recession given the high number of jobs available right now (10.7 million) and the relatively high net worth of consumers.
But in such an unusual environment, no scenario should be ruled out for equities, Sosnick said, including a roughly 40% magnitude correction.
“I refuse to take any scenario off the table,” Sosnick said. “None of the Fed governors have seen it in her professional life. Only older investors have seen it in their careers.”
He added: “The few times the Fed tried to withdraw liquidity from the market, it didn’t go well. They were able to stop withdrawing liquidity because inflation wasn’t a problem.”