The last week’s market highlights:
A jumping jobs report puts fear of the Fed into markets
- July’s stellar employment data confirmed that the U.S. jobs engine still has fuel in the tank and stoked fears of more aggressive rate hikes from the Federal Reserve. The S&P 500 Index fell 0.2% in the wake of the report’s release last Friday, trimming the prior four days’ modest advance.1 Sectors such as consumer discretionary and information technology, which posted gains earlier in the week, lagged as investors priced in a greater chance of another 75-basis-points (bps) rate hike at the next Fed meeting in September.
- In the fixed income arena, the yield on the bellwether 10-year Treasury jumped 16 bps for the week, to 2.83%, with nearly all of the increase coming on Friday. But the 2-year Treasury yield, which is highly sensitive to potential changes in Fed policy, climbed even more (21 bps), finishing at 3.24% and further inverting the yield curve.2
- U.S. corporate bonds continued to rally, with spreads over U.S. Treasuries narrowing as severe recession risks appeared to be easing for the time being. Both high yield and investment grade corporates participated in the week’s gains, posting total returns of 0.9% and 0.3%, respectively, adding to July’s strong performance.3
- The Bank of England (BoE) raised its policy rate by 50 basis points, its largest hike since 1995.4 The BoE also lifted its peak inflation forecast to over 13% and now expects a recession beginning in the fourth quarter of 2022 as high energy costs squeeze consumers.
- This week’s July consumer price data should show inflation moderating thanks primarily to a sharp drop in energy prices. Core inflation, which excludes food and energy costs, will likely stay hot, providing little relief for those seeking a break from higher prices.
Each week, we present our featured topics in the context of the major themes from Nuveen’s most recent global investment outlookOpens in a new window:
- U.S. economy: Recession has become a 50/50 proposition by the end of next year.
- Global economy: High commodity prices threaten emerging markets and energy importers.
- Policy watch: Central banks are tightening but now risk going too fast, too far.
- Fixed income: Corporate credit and municipal bonds offer some recession protection and compelling value.
- Equities: Too soon to call a market bottom with recession risks looming, but U.S. growth stocks have cheapened a lot.
- Asset allocation: Plenty of opportunities for investors with a tolerance for volatility.
Quote of the week:
"Good is not good when better is expected." – Vin Scully
A scorching hot U.S. job market challenges policymakers on inflation
Weeks of recession chatter probably didn’t prepare investors for the July U.S. employment report, which showed shockingly strong hiring demand. Payrolls grew by 528,000 — more than double consensus expectations — and prior months’ tallies were revised modestly upward.5 The unemployment rate fell to a pre-pandemic level of 3.5% amid a small decline in the size of the labor force.6 Among prime-age workers (ages 25-54), both labor force participation and the employment-to-population ratio ticked up, another positive.7
It’s difficult, if not impossible, to square this report with the idea that the U.S. economy is sliding into severe recession or, indeed, is likely to do so anytime soon. Employers continue to run into a brick wall of constrained labor supply. Even after a nearly one million drop in job openings as measured by the latest JOLTS (Job Openings and Labor Turnover Survey) report, the ratio of openings to unemployed workers is still nearly two to one.8 Indeed, the drop in job vacancies may be due to those positions having already been filled.
Other evidence of a hot labor market in July’s employment release included faster-than-forecast growth in average hourly earnings. While not a pure proxy for wages, growth in this metric corroborated what we’ve seen in other measures of compensation lately, such as the Atlanta Fed Wage Tracker and the Employment Cost Index.
On balance, we think this report likely gives the Federal Reserve the “all clear” to implement another 75 basis point (bps) rate hike at its September meeting. Until then, Fed Chair Jerome Powell and his colleagues will examine incoming data, including another employment report and several inflation readings, before making a final decision on their next policy move.
Putting the brakes on hiring demand may be an effective way to bring down inflation, but it can also harm consumer spending, which has been the main source of support for the economy this year. If the Fed’s tightening timetable isn’t right, that drop in demand could come well before inflation moderates significantly. For more on that, see below.
Will the economy pay the price for the Fed’s inflation fighting?
After a dismal first half of the year, markets have been chipper lately. The S&P 500 Index rallied more than 9% in July. Both investment grade and high yield corporate debt, as well as municipal bonds, also gained last month as spreads narrowed. Surprisingly, this bullishness took place despite slowing economic growth, persistently high inflation and larger-than-expected interest-rate hikes from the Federal Reserve and other major central banks.
In our view, falling interest rates, which led to lower borrowing costs, put some glide in the markets’ stride. Markets have become more focused on risks of lower growth or recession, which tend to push interest rates down, and less on the risk of inflation, which tends to push interest rates up. For example, the bellwether 10-year Treasury yield plunged 31 basis points (bps) last month, to 2.67%, while the 2-year yield, which tends to track the path of future Federal Reserve policy, finished July 56 bps below its mid-June high.9
Of course, this was all before Friday’s blowout July employment data, which resuscitated fears of a wage-price spiral and significant further tightening from the Fed. Immediately following that report, Treasury yields rose across all maturities and market-based expectations for the Fed’s target rate by next spring increased by 25 basis points. So market volatility could persist, especially if inflation continues to top forecasts and the Fed keeps its foot firmly on the brake.
Whether the Fed can cool inflation without derailing the labor market is the subject of much debate. Some economists think that more hawkish monetary policy can reduce the threat of inflation by reducing excess job openings without causing unemployment to rise materially. Fewer openings mean fewer hires, the reasoning goes, and thus less upward pressure on wages. Another group cites data showing that the unemployment rate has spiked every time job vacancies have fallen sharply, as they did during the 2008 global financial crisis.
What those on both sides of the debate seem to agree on is that the Fed needs to weaken demand for workers in order to tame inflation. The question is how hard the Fed can push to try to slow the economy — and with it, the pace of hiring — without increasing layoffs. Although the answer is not at all clear, virtually no economist believes it’s possible to reduce job openings without some related increase in the unemployment rate.
Economic theories aside, the next inflation data point will arrive this Wednesday, with the release of the Consumer Price Index (CPI) for July. We expect CPI to begin easing down from June’s 9.1% year-over-year headline rate thanks to:
- Declining commodity prices. (This should contribute to cooler inflation worldwide as well.)
- An ongoing drop in goods prices, as consumers have been spending more on services.
- Fewer supply chain backlogs, which could help ease supply and demand imbalances that have been contributing to high inflation.
Additionally, having already hiked by 150 basis points in 2022 so far, the Fed has played a significant role in cooling the hot housing market, with higher mortgage rates crimping demand. And while consumer spending growth has remained positive, if inconsistent, this year, tighter financial conditions have reduced household net worth by trimming financial asset prices. That should eventually translate into somewhat lower spending growth, and, with it, lower consumer price inflation.
- Marketwatch, FactSet
- Federal Reserve via Haver
- Bloomberg
- Bloomberg
- Bloomberg, Bureau of Labor Statistics (BLS)
- BLS
- Bloomberg
- Bloomberg
- Federal Reserve via Haver
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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