Lousy Jobs → Fewer Hikes → Stocks Happy

Ahead of a long weekend in the US, traders had to reckon with a major set of economic statistics this morning.  The Bureau of Labor Statistics released the May employment data ahead of the market open.  Both the Payrolls and Unemployment reports offered surprises, and both stocks and bonds reacted positively, even if at least one of those numbers was quite disappointing.

For those who slept late today, the change in Nonfarm Payrolls was a bit of a shock.  May’s data showed an increase of only 57,000, well below the 113,000 consensus.  Furthermore, April was revised down to 129,000 from 172,000, and the two-month revision of -74,000 implied that March was revised down by another 43,000.  There is really no way to sugarcoat those statistics.  Unfortunately, yesterday’s ADP Employment Change report gave us a clue to today’s shortfall that was generally ignored.  It showed a gain of 98,000, which was shy of the 120,000 consensus.  It’s a shame that the lesser-followed report is generally an unreliable precursor to the major government release that typically follows later in the week.

Superficially, the Unemployment Rate seemed to offer some encouragement when it dipped to 4.2%.  That was a 0.1% drop from last month’s 4.3%, which was also the consensus for this month.  That seemed like both a win and a contradiction until we noticed that the Labor Force Participation Rate fell to 61.5%, the lowest in more than five years, which was well below the consensus that matched last month’s 61.8%.  The improvement in the Unemployment Rate is likely better explained by people leaving the labor force rather than an improvement in job-seekers’ prospects.  Even the seemingly good news had a negative aspect.

Nonetheless, stock traders could find something encouraging amidst a set of gloomy statistics.  The weaker labor picture pushed back market expectations for imminent rate hikes.  Fed Funds futures went from fully pricing in a first hike in October to pricing one in December and reduced expectations for further hikes next year.  (Traders on IBKR Prediction Markets take a different view, with a 41% “No” for a rate above 3.625% in December.)  Pre-market ES futures initially rallied by about 0.6%, but pulled back to be up only slightly just ahead of the open.  Then, they found a second wind after the bell rang, and the S&P 500 (SPX) traded up by nearly 0.8% within the first hour. 

It seems, however, that exuberant traders got carried away a bit this morning.  An economy weak enough to forestall Fed rate hikes is not necessarily a great reason to rally.  Key indexes began to lose steam, in some cases dramatically.  By noon, SPX was down about 0.2% and the Nasdaq 100 (NDX) was down by more than 1.5%.  As you might have guessed from that divergence, tech stocks led the decline.

Yet below the surface, there is still a strong current of optimism.  As I type this, only two SPX sectors are trading lower: Technology, and tech-adjacent Communications.  Industrials, which has been a source of strength, is flirting with unchanged levels, but Healthcare, Staples, Materials, and Financials are all posting healthy advances.  NYSE advances are leading decliners by a roughly 2:1 margin and roughly 200 more SPX components are rising than falling.  But if people want to take profits in tech, including a semiconductor sector that is down by nearly 5%, it is hard for major benchmarks to escape that gravitational pull.

This is a consequence of rotation when one sector dominates key market capitalization-weighted measures.  It takes an awful lot of buying in the smaller sectors to overcome the downdraft in the largest ones.

One other thing comes to mind when thinking about the consequences of today’s jobs report.  Fed Chair Warsh has been relatively tight-lipped since assuming his new role, particularly when it comes to the “full employment” portion of his dual mandate.  What little he has said, whether at his inaugural post-FOMC press conference or at yesterday’s central bank confab in Portugal, has focused much more on the “stable prices” aspect.  Yet a response from that post-FOMC presser sticks out to me as we parse economic data today and in the future:

“So I think financial markets perform best when they react to incoming data. I think they—the financial markets work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information? The more that markets are paying attention to what’s happening in the real economy, deciding what’s good data and what’s less good data, the more financial markets can price what they believe is the most likely and what are the tail risks.”

Perhaps we should be taking the new Chair’s comments to heart.  If it looks like good news, that’s good; if it looks bad, it’s not.  Maybe we should stop the financial jiu-jitsu of trying to make the data fit our preferred narratives.  Just a thought…

Happy 4^th of July to those who celebrate, and a Happy 250^th Birthday to the USA!