We’re “Playing the Ref” Today

In an exuberant market, stocks don’t need a reason to rally – an excuse is all that’s necessary.  Today, a stunner of a July jobs report, hardly a positive one by any stretch of the imagination, offered enough of a rationale for a market that was already predisposed to move higher.  The report rejiggered market expectations for impending rate hikes.  At the last FOMC press conference, Chair Warsh said, “Market participants are learning to play the ball, not the referee.”  Today, they’re “playing the referee.”

This morning, all eyes were on the July jobs report when it was released at 8:30 ET.  I would not be surprised if some gasps were heard on large trading floors.  Nonfarm Payrolls shrank by 23,000, a difference of more than 100,000 from the 80,000 gain that economists expected.  Even worse, the two-month revision was -103,000; since June was revised lower by 37,000, it implies that May was revised down by an additional 66,000.  Sure, the Unemployment Rate improved to 4.1% from 4.2%, but that was largely thanks to a Labor Force Participation Rate (the denominator in the Unemployment Rate) that fell to 61.4%.  That was 0.1% below last month’s level and 0.2% below consensus estimates.  Average Hourly Earnings also fell, rising by only 0.1% in July after moving up by 0.3% in June.  Stocks of course rallied on the news.

OK, that last sentence was a bit snarky.  Bond yields, particularly at the short end of the yield curve, fell sharply.  We saw 2-year Treasury yields drop by more than 8 basis points in the immediate aftermath of the report, though that move has been roughly cut in half by late morning.  The drop in yields is the result of diminishing expectations for a rate hike at the September FOMC meeting.  Both the CME Fed Watch and IBKR Prediction Markets show a roughly 43% chance for a hike, with both having dropped from around 60% prior to the jobs report.

IBKR Prediction Markets Contracts for September Fed Funds, 1 Month Data

Source: Interactive Brokers

Considering that pre-market ES (S&P 500 Mini) futures were up about 0.25% before the data arrived and more than doubled those gains immediately afterward, at least some traders were hoping for a lousy number rather than a solid one.  The chart below shows the steady rise in pre-market futures, the jolt higher at 8:30, the brief bout of profit-taking that occurred shortly after the opening bell, and then the resumption of the prior advance that continues as I type this. 

September ES Futures, Today, 1 Minute Candles

Source: Interactive Brokers

It is important to remember that Chair Warsh had been positioning himself as far more focused on inflation than labor in his public comments so far.  As we wrote on the day after the July 29^th FOMC meeting:

… [Warsh] appeared to paint himself as a single-mandate Chair, focused primarily on “stable prices” (the term “inflation” was mentioned 41 times during the press conference, 29 of them by Warsh) over “full employment” ([labor] mentioned only thrice by Warsh), fixed income investors felt that there was insufficient concrete proof of definitive measures toward achieving that goal.

Certainly, the weaker labor picture offers sufficient reason for the FOMC to refrain from an immediate hike.  Furthermore, there was a disinflationary aspect to the slower rise in Weekly Hourly Earnings. 

It has been my contention for some time that the FOMC, or at least its Chair, would be disinclined to raise rates prior to its December meeting.  Given that the President who recently appointed Warsh has a well-known predilection for lower rates, the threshold for a rate hike ahead of the midterm elections seems especially high.  It was already credible for the Chair to advocate for inaction until his new working groups (the Chairman’s Task Forces for Advancing Monetary Policy) had an opportunity to complete their work.  Instead, a saggy labor market accompanied by recent inflation reports that were relatively tepid is offering quite justifiable reasons for inaction.

It is, of course, welcome news that rate hikes are not in the immediate offing.  Yet the equity market’s enthusiasm seems based less upon “playing the ball” –meaning the data itself – than on “playing the referee,” – basing its reaction to the FOMC’s likely reaction to today’s data.  Considering Warsh’s lack of interest in intra-meeting commentary, we’re likely not going to know his opinion about today’s reaction until the Kansas City Fed’s Jackson Hole conference begins on August 27^th.  That’s the next time the referee is scheduled to speak.