- The US economy added 528,000 jobs in July, the Labor Department said on Friday.
- This signals the labor market remains in good shape, and the Fed can proceed with hawkish policies.
- That’s bad news for stocks, many on Wall Street said on Friday.
On Tuesday, San Francisco Fed President Mary Daly went on a LinkedIn livestream with CNBC’s Jon Fortt and sent a firm message: the central bank is “nowhere near” done tightening policy.
Daly’s directness was very deliberate, some say. The Fed trotted out one of its most notorious doves to walk back what many investors had perceived as wishy-washy comments from Jerome Powell at the Federal Open Market Committee’s July meeting the week before.
Markets were starting to doubt the Fed’s resolve to tighten and were sniffing out a pivot ahead. Stocks continued their rally from mid-June.
With Daly’s appearance, “they’re telegraphing to the market, in essence, recalculate,” said Quincy Krosby, the 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 in with an olive branch for investors.
Early Friday morning before the market opened, the dovish pivot narrative was completely smashed as the Labor Department announced a monstrous jobs report. The US had added another 528,000 jobs in July, they said, more than double the number expected.
A strong jobs report is usually a positive for the economy. More jobs mean the economy is in a healthy place — when people have jobs they spend money, and this supports corporate earnings.
But with inflation at a 41-year-high of 9.1%, markets viewed the strong labor market through at least a partially negative lens. The Fed has been fighting inflation aggressively by raising interest rates at the fastest pace since 1994 and shrinking the amount of assets they hold.
A tight labor market is likely to continue to fuel demand and therefore inflationary pressures. It also signals to the Fed that they’re not yet creating damage to the labor market with their hawkish policies, so they can proceed as they were without caution.
Eventually, uber-hawkish policy is bound to catch up with the economy — and therefore stocks. Plus, liquidity in the financial system drying up thanks to Fed tightening isn’t good for risk assets like stocks.
That’s why the market fell on Friday morning in reaction to the jobs report. And more downside is ahead, many on Wall Street say.
Why stocks are ‘not out of the woods yet’
Steve Sosnick, the chief strategist at Interactive Brokers, said he expects the S&P 500 to fall and retest the June lows of around 3,666, 11% from current levels around 4,130.
Sosnick said the volatility in the short-term bond market that has ensued since June tells him that further downside is ahead in stocks, which have been strong over the same period.
“If the bond market can’t come to a consensus about short-term rates, how can the stock market be so certain to change its consensus,” he said, arguing that bond traders have a much “purer” view of where monetary policy is headed than stock traders. “If risk-free assets are volatile, how can you not expect volatility in risky assets, such as stocks,” Sosnick said. “Those are the messages that the bond market is screaming in our face.”
Krosby also said she sees up to 10% more downside in the S&P 500. John Lynch, the CIO at Comerica Wealth Management, said further selling is ahead, and the Fed is more likely now to hike rates by 75 basis points at their September meeting , what would be their third hike of that size in a row.
“Wage growth is alarming for Fed officials, likely bringing 75 basis points back on the table for the September meeting. Fed fund futures already moving higher,” Lynch said in a statement on Friday. “We believe this development signals the end of the recent bear market rally.”
Matt Peron, the director of research at Janus Henderson, echoed these sentiments, too, saying stocks are “not out of the woods yet.”
How severe a potential sell-off is seems to depend on either inflation cooling off quickly, or the US economy’s ability to fight off a recession in the face of the most hawkish 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 US is in a unique position to fight off a recession given the high number of jobs available right now (10.7 million) and consumers’ relatively high net worths.
But in such an unusual environment, no scenario should be ruled out for stocks, Sosnick said, including a correction to the magnitude of something around 40%.
“I refuse to take any scenario off the table,” Sosnick said. “None of the Fed governors have seen this in their professional life. Only the oldest investors have seen this during their careers.”
He added: “The few times the Fed has tried to withdraw liquidity from the market, it hasn’t gone well. They’ve been able to stop withdrawing liquidity because inflation wasn’t a problem.”