- 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 that the Fed can continue its hawkish policies.
- That’s bad news for equities, many on Wall Street said on Friday.
On Tuesday, San Francisco Fed President Mary Daly livestreamed on LinkedIn with CNBC’s Jon Fortt and sent a strong message that the central bank is “far from” completing its tightening policy.
Daly’s frankness was very deliberate, some say. The Fed pulled out one of its most notorious doves to walk back what many investors had perceived as wishy-washy comments by Jerome Powell at the Federal Open Market Committee’s July meeting the previous week.
Markets were beginning to doubt the Fed’s will to tighten and were smelling an upcoming pivot. Equities continued their rally from mid-June.
With Daly’s appearance, “they’re telegraphing to the market, basically, recalculating,” said Quincy Krosby, chief global strategist at LPL Financial.
Daly’s comments were followed by similar statements from other Fed chairs, 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 olive branch for investors.
Early Friday morning before the market opened, the dovish pivot narrative was completely shattered when the Department of Labor announced a monstrous jobs report. The United States had added 528,000 more jobs in July, they said, more than double the number expected.
A good jobs report is generally positive for the economy. More jobs means the economy is healthy – when people have jobs, they spend money, which supports business profits.
But with inflation at 9.1%, its highest level in 41 years, markets saw labor market strength through at least a partially negative lens. The Fed has fought inflation aggressively by raising interest rates at the fastest pace since 1994 and reducing the amount of assets it holds.
A tight labor market should continue to fuel demand and therefore inflationary pressures. It also signals to the Fed that it is not yet causing damage to the labor market with its hawkish policies, so it can continue as it was without caution.
Eventually, ultra-hawkish politics is bound to catch up with the economy – and therefore equities. Moreover, the drying up of liquidity in the financial system thanks to Fed tightening is not good for risky assets like equities.
That’s why the market fell on Friday morning in reaction to the jobs report. And more downsides are to come, say many on Wall Street.
Why stocks are ‘not off the hook yet’
Steve Sosnick, chief strategist at Interactive Brokers, said he expects the S&P 500 to fall and retest June lows of around 3,666, 11% from current levels of around 4. 130.
Sosnick said the volatility in the short-term bond market that has ensued since June signals to him further downside is ahead for equities, which have been strong over the same period.
“If the bond market can’t come to a consensus on short-term rates, how can the stock market be so certain to change its consensus,” he said, saying bond traders have a lot of vision. more “pure” in the direction of monetary policy. is headed as 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 the bond market is screaming in our faces.”
Krosby also said she sees up to 10% further decline in the S&P 500. John Lynch, the CIO of Comerica Wealth Management, said further selling is ahead and the Fed is more likely to raise prices. rate of 75 basis points at their September meeting. , what would be their third hike of this size in a row.
“Wage growth is alarming for Fed officials, likely bringing 75 basis points back to 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, director of research at Janus Henderson, also echoed those sentiments, saying stocks “are not out of the woods yet.”
The severity of a potential selloff appears to depend on whether inflation slows rapidly or whether the US economy is able to fight a recession in the face of the most aggressive environment in decades. Or – if a recession cannot be avoided – how mild it is.
Goldman Sachs analyst Jason English said in a webinar last week that the United States was in a unique position to fight a recession given the high number of jobs currently available (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 correction of around 40% in magnitude.
“I refuse to take any script off the table,” Sosnick said. “None of the Fed governors have seen this in their professional lives. Only the senior investors have seen this in their careers.”
He added, “The few times the Fed tried to take cash out of the market, it didn’t go well. They were able to stop taking cash out because inflation wasn’t an issue.”