INVESTORS are struggling to decide if the glass is half full or half empty this week. Sometimes good news for the economy can be bad news for the markets.
Booming job market
Last week’s US jobs data provided a big positive shock to the economy and a negative shock to the stock market. The 528,000 new jobs created in the US economy in July were more than double the forecast and significantly higher than the roughly 400,000 created the previous month.
While this is obviously good news for American workers and suggests that the US economy is further from recession than feared, investors took it badly. That’s because the hot labor market is giving the Federal Reserve all the ammunition it needs to justify another giant rate hike at its next meeting in September. After increases of 0.75 percentage points in June and July, the same is expected next month.
The magnitude of the shock played out in the bond market where the yield on a two-year Treasury bill – usually the bond maturity most closely tied to interest rate expectations – jumped by 0.21 percentage points to 3.25%. It’s a big step in the usually quiet world of fixed income.
What does this mean for stocks?
The sharp rise in bond yields had a negative impact on stock prices, with the S&P 500 and especially the Nasdaq retreating at the end of the week. It was yet another positive week for the market, but the July rebound now appears to have run its course.
Mary Daly, head of the San Francisco Federal Reserve, said she believed the US central bank was “far from” finished in its fight to bring inflation under control. Investors had clung to straws that the Fed wouldn’t have to tighten policy as much as they feared. That optimism now seems premature, as the peak of the interest rate cycle is now set at 3.64% next spring, significantly higher than expected just a week ago.
What about those inflation fears?
Investors won’t have to wait long to see how the strength in the job market affects inflation numbers. On Wednesday this week, US Consumer Price Index (CPI) data should confirm that core, or core, inflation is now even higher than the headline rate. This is because the worst is now behind us in terms of rising energy and food prices, but the impact is rippling through the rest of the economy.
Meanwhile here, the Bank of England is worried about both inflation (13% at its worst next year) and growth, having revised down its forecast for the economy last week as it unveiled the largest rate hike (0.5 percentage point to 1.75%) in nearly 30 years. UK investors breathe a sigh of relief that the UK stock market is focusing more on global themes than the domestic economic backdrop.