Last Friday, markets received a bombshell from a weak July NFP (non-farm payrolls) employment report, with only 73,000 jobs added versus expectations of 110,000. Meanwhile, the unemployment rate ticked up to 4.2% from 4.1%, but remains still near historical lows.
Perhaps most disappointing, however, were the revisions to the prior two months’ data, which erased over a quarter million jobs in May and June combined.
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Those revisions brought the 3-month average number of jobs created down to a paltry 35,333, compared with an average of 146,000 for the prior 12 months. The prevailing wisdom is that it takes at least 70,000 to 80,000 jobs to be created just to match incoming labor market entrants and keep the unemployment rate steady.
Clearly, a significant slowdown in job creation in recent months is evident, causing markets to completely re-assess the likelihood of a quarter-percent rate cut from the Federal Reserve at its Sept. 17-18 meeting.
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Fed, market react to job market stumble
According to the Chicago Mercantile Exchange (CME) FedWatch tool, futures contracts are now showing a 93.2% probability of a 0.25% rate cut, up from just 38.2% odds as of July 15.
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Markets reacted poorly to the data, as expected, with major stock indexes declining by more than 1.5% on the day.
Subsequent stock price action saw the major indices recover slightly on Monday. However, stocks could only close the price gaps following Friday’s weaker-than-expected data, exposing a negative technical outlook. Tuesday saw stock index prices decline again, leaving them below levels from last Friday.
Aren’t Rate Cuts a Positive for Stock Market Sentiment?
Typically, a rate cut or expectations of lower rates in the future generally support stocks. Lower borrowing costs usually correspond to better sales and earnings for companies, propping up share prices.
But this time seems different in light of Friday’s disastrous jobs numbers and the negative revisions to prior months’ data. Will the Fed be cutting rates because inflation has been deemed under control and the economy is running smoothly? Not bloody likely.
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The most recent US CPI (Consumer Price Index) report saw core prices (excluding food and energy) increase to 2.9% from year-ago levels, indicating that inflationary pressures are still a threat. That’s well above the Fed’s 2% inflation target rate and not a likely reason for the FOMC (Federal Open Market Committee, the Fed’s rate-setting body) to cut rates.
Far more likely is the scenario that the recent slowdown in the labor market is causing the Fed to rethink the US growth outlook, not positively. In that sense, markets are on tenterhooks to see if the labor market deteriorates further, jeopardizing the growth outlook for the coming months.
The Importance of the Labor Market to the Overall Outlook for Stocks
There is a pretty clear line to follow: the healthier the labor market, the better the economy should perform, and stocks should be supported by it.
The worse the labor market is, the more downside risk to the economic outlook and the greater the potential pressure on share prices.
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That’s because jobs directly translate into disposable income and consumer spending, which accounts for approximately 70% of US GDP (Gross Domestic Product, a measure of a country’s output and growth). So, as goes the labor market, so goes personal consumption and the broader economy, and likely near-term share price movements.
In a recent interview with Caroline Woods of TheStreet.com, Mark Zandi, chief economist at Moody’s Analytics, suggested that layoffs are the key trigger to a potential recession.
A claims number above 250,000 is considered a recessionary signal, and we’re only averaging just below that at around 220,000.
Inverse relationship of jobless claims to the S&P 500 indexÂ
This brings us to the next data point in US labor market statistics: Thursday’s initial jobless claims for the week ending August 2.
Weekly jobless claims data are the closest we can get to a real-time reading on the state of the jobs market.
Historically, the S&P 500 index moves opposite to weekly claims data, with a -0.5 to -0.7 correlation level suggesting a moderate-to-strong inverse relationship. This implies that a surprise increase in jobless claims, say above 240K, could send stocks lower, while an improved (lower) initial claims report likely translates into further stock market gains.
If an as-expected number is received, and markets don’t breathe a sigh of relief and continue to sell, it would be a strong signal that a more protracted market turn lower may be in process.
What it means for investors
According to the four-week moving average, weekly jobless claims are running at 221,000, with the most recent claims data showing 218,000 filings for the week ending July 26. Continuing claims remained elevated at 1.94 million, suggesting a stable but sluggish hiring environment.
With the current focus on the strength of the US labor market, any surprise in reported claims could see an outsized reaction in market share prices. Currently, economists’ expectations for weekly jobless claims are 220,000, with estimates ranging from 217,000 to 225,000.
Overall, jobless claims have been steady at around 220,000, indicating a stable yet soft labor market. But remember, weekly claims data can be significantly affected by seasonal adjustments (think of fired government employees coming to the end of their severance packages and then filing a first-time claim), so there is always room for a surprise in the weekly numbers.
Short-term Investors should carefully monitor the weekly claims numbers and be ready to react to any outsized change in initial claims. If a surprisingly high jobless claims number comes in, it could be interpreted as yet another indication of labor market vulnerability. This would likely negatively impact stocks and Treasury yields, at least in the short term.
At the moment, the market is still split on whether a rate cut is good for markets or if labor market deterioration is sufficiently worrisome that the economic picture starts to slant toward recession. Pay attention to price movements, as they will reveal the market’s true future direction and whether buying the dip or selling the rallies is the way to go.
Earlier this week, I wrote that last Friday’s NFP debacle was a significant turning point in overall market direction and that the technicals pointed to further downside potential. You can look at the charts highlighted in that story to gauge key technical price levels for future reference.
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