5 Key Takeaways from US Markets This Week

Key Points

• Strong US jobs data on Friday has boosted expectations for a 75 bps rate hike from the Fed this month.
• US yields are set to end the week sharply up as a result, whilst stocks have been surprisingly resilient.
• USD surged last week as a result of strong data and hawkish Fed bets plus safe-haven demand on international developments.

Strong US Jobs Market Remains Strong

Data released by the US Bureau of Labour Statistics on Friday showed that the US jobs market remained in rude health in June. 372K jobs were added to the US economy last month, more than the median economist forecast for a gain of 268K. The unemployment rate remained unchanged at pre-pandemic levels of 3.6%, as expected. The YoY rate of Average Hourly Earnings growth clocked in at 5.1%, a tad above the expected drop to 5.0% from 5.3% a month earlier.

In sum, a very robust set of numbers, which come after JOLTs Job-Opening data earlier this week showed that the demand for labor remained very strong as of the end of May. According to JOLTs, there were still well over 11 million job openings at the end of May, well above the number of unemployed persons in the US. A lack of labor supply, with the participation rate still substantially below pre-pandemic levels (at 62.2% in June versus over 63.0% in early 2020) remains the main factor holding the jobs market back.

Fed Set to Continue Rapid Pace of Rate Hikes

The latest US jobs data “solidifies the view that there’s going to be a 75-basis-point increase in the next two weeks,” Reuters quoted Tom Plumb, portfolio manager of the Plumb Balanced Fund, as remarking on Friday.

“I don’t think that there’s any debate now that the Fed will be raising 75 basis points” at its July meeting, added Seaport Global Holdings managing director Tom di Galoma according to Reuters.

Three Fed policymakers speaking earlier this week threw their support behind another 75 bps rate hike from the Fed at its upcoming meeting. Atlanta Fed President Raphael Bostic said he “fully” supports another 75 bps hike.

Meanwhile, Fed Board of Governor’s member Christopher Waller and St Louis Fed President James Bullard both also said they support another 75 bps hike at the upcoming July meeting. However, both said they think the pace of rate hikes will slow in September.

A deterioration of the near-term inflation outlook prompted the Fed to accelerate rate hikes with a 75 bps move last month, the meetings of that minute that were released this week explained. The minutes of the June meeting added that a hike of either 50 or 75 bps was likely in July.

According to Reuters, money markets were last pricing a 90% chance of a 75 bps rate hike at this month’s upcoming meeting. Moreover, money markets now price the Fed funds rate reaching a peak of 3.58% in March 2023, versus 3.48% on Thursday.

In the absence of a massive downside surprise from next week’s US Consumer Price Inflation data, which is expected to show that US price pressures remain close to multi-decade highs, a 75 bps hike from the Fed this month seems set in stone.

Yields Rally on Strong Data, Fed Tightening Bets

US government bond yields are up sharply across the curve this week. The 2-year was last around 3.11%, up around 27 bps. The 10-year was last around 3.09%, up around 20 bps. Traders cited this week’s strong data as increasing confidence that the Fed will press ahead with rapid monetary in the upcoming months as providing the boost.

A key development this week was that key parts of the US treasury curve returned to inversion. As noted, above, the 10-year yield is currently about 2bps below the 2-year yield. Inversion of the 2s/10s spread has been classically viewed as a reliable predictor of an upcoming US recession.

While this week’s strong labor market data and solid service sector survey data (provided by ISM) suggest that the US economy probably still grew in June, many analysts suspect rapid Fed tightening to push the US economy into recession by the year’s end/early 2023.

Wells Fargo Investment Institute (WFII) published a new US GDP forecast on Thursday. They now foresee “a moderate US recession beginning mid-2022 and extending into mid-2023,” marked by “persistent inflation and declining economic growth” until the end of 2023. Their guess for full-year 2022 GDP growth is now of a 0.2% decline.

According to WFII, the pessimistic new forecast reflects how “strong labor market and abundant cash supports are eroding under persistent inflation and the Federal Reserve’s increasingly aggressive policy response”.

Stocks Recover Despite Hawkish Shift in Fed Bets

If you had said at the start of the week that strong US data would boost yields and Fed tightening bets, most would have thought this would have weighed on equities. But this hasn’t been the case.

The S&P 500 was last trading around 3,890 on Friday, a tad lower on the day, but still up more than 1.5% on the week. The typically rate-sensitive tech/growth stock dense Nasdaq 100 is doing even better, with gains of about 4.0% on the week at the time of writing and the index back above 12,000.

Analysts have cited a couple of factors as supporting equities. Firstly, commodity prices from energy to industrial metals and agricultural products are down on the week and substantially below their June highs. This has eased fears about persistent inflation and upped hopes that, in the US, inflation has now peaked.

Meanwhile, though this week’s economic data supports the case for a 75 bps rate hike this month, some argued that this week’s Fed minutes contained hints that the bank may back off rate hikes if the economy weakens too much. The minutes revealed that Fed officials were aware of the risk that rate hikes have a “larger-than-anticipated” impact on economic growth.

“It’s starting to feel like real money is starting to come back,” Reuters quoted Louis Ricci, head trader at Emles Advisors, as saying on Thursday. “There’s no reason that the market cannot go down another 30%, but we think the risk is 30% to the downside but three to four times that to the upside”, he added.

Of course, some analysts have dismissed this week’s rally as a so-called “dead-cat bounce”. If next week’s US Consumer Price Inflation data for June was to reveal a nasty upside surprise (like the May data did back in June), then stocks could quickly hand back recent gains.

Dollar Surges to Fresh Multi-Decade Highs

Strong US data and a hawkish shift in Fed bets versus the start of the week helped push the US Dollar Index (DXY) higher by nearly another 2.0% this week and to fresh multi-decade peaks above 107.00. The DXY has now gained in five out of the last six weeks and is now nearly 12% up on the year.

The trade-weighted basket of major USD pairing also got support from safe-haven demand due to international developments. Namely, concerns are growing about a Russian embargo of gas into the EU that risks sending its economy into stagflation this year. The euro was pummelled as a result, while pound sterling also suffered amid concerns about the weak stagflationary economy there.