Financial markets are starting to acknowledge the likelihood of higher U.S. interest rates for a longer duration. This shift in sentiment comes on the back of a blowout private-sector jobs report for June from ADP, along with expectations of another strong labor-market reading.
The data has finally become too compelling to ignore. In June, ADP reported the addition of 497,000 private-sector jobs, more than double the forecasted number. As a result, the policy-sensitive 2-year rate TMUBMUSD02Y, 5.035%, surged beyond 5%—its highest level in 17 years. Similarly, the benchmark 10-year yield TMUBMUSD10Y, 4.053%, surpassed the significant 4% mark associated with a healthy U.S. economy. The Dow industrials DJIA, -1.07% experienced a brief drop of up to 517 points, and all three major indexes SPX, -0.84% COMP, -0.90% traded lower during New York afternoon.
Although there is a possibility of a repeat pullback in stocks similar to Thursday’s market movement in the coming months, investors may find confidence in the fact that the lows experienced by the Dow industrials and the S&P 500 last October could hold up. Brian Jacobsen, chief economist for Annex Wealth Management in Elm Grove, Wisconsin, which manages $4.2 billion in assets, explains that this optimistic outlook is justified by the decline in headline inflation since its peak of 9.1% last June, despite persistent core readings. Jacobsen draws comparisons to the 2012-2015 period characterized by a “taper tantrum” in U.S. yields and the Federal Reserve’s necessity to adjust monetary policy, along with a robust economy leading to a jobless recovery.
In summary, financial markets are gradually accepting the notion of higher U.S. interest rates in the foreseeable future as a result of the impressive jobs report.
Awakening to the Fed’s Unfinished Job
Over the past few days, the market has experienced significant movements, driven by various factors including strong job gains, reduced quit rates, manufacturing weakness, and service-sector strength. These developments have sparked a realization that the Federal Reserve’s job is far from complete.
While some expect dips in U.S. equities, there is consensus that this is not the start of a bear market nor a correction. In fact, many believe that there are ample opportunities to buy into the market as it navigates a choppy path. For those looking for investment opportunities, it may be advantageous to position oneself for a forthcoming recovery in corporate earnings.
Throughout this year, investors and traders have been preparing for the Federal Reserve to conclude its aggressive rate hikes and shift gears towards cutting borrowing costs. However, one of the hurdles in this transition is the persistent inflationary pressures that remain unexpectedly high. Despite policy makers’ emphasis on core inflation readings, whether derived from the consumer-price index or the Fed’s preferred personal-consumption expenditures index, inflation is not falling at the desired rate.
The continuous positive surprises in the U.S. labor market further compound the challenges faced by the Federal Reserve in its fight against inflation. This has had repercussions that extend beyond the stock and bond markets, impacting oil and gold futures. Additionally, the dollar has experienced increased support, while the CBOE Volatility Index, a measure of market expectations for volatility, experienced a surge.
Read: Wall Street investors grapple with how ‘last mile’ of U.S. inflation will play out
Employment Outlook: Positive Growth Expected in June
The highly anticipated nonfarm payroll report, scheduled to be released by the U.S. Labor Department on Friday, is projected to reveal a significant increase in job creation. According to a survey conducted by The Wall Street Journal among leading economists, it is estimated that the month of June will see a gain of approximately 240,000 jobs, further driving the positive momentum in the labor market.
Concurrently, economists are forecasting a remarkable 3.6% unemployment rate, further indicative of the economy’s robust performance. While the official report is yet to be published, experts highlight that the release of the ADP private-sector report can serve as an insightful indicator for the forthcoming figures. However, it is important to note that ADP clarifies that it does not attempt to predict the government’s official monthly job report.
As employment continues to be a focal point for economic recovery, analysts and stakeholders eagerly await the release of Friday’s nonfarm payroll report. The findings are expected to provide valuable insights into the state and direction of the nation’s job market, shaping perceptions and investments strategies moving forward.
The Implications of Job Gains and Rising Interest Rates
Introduction
Job Gains Exceeding Expectations
Moya believes that the upcoming job gains report could surpass expectations, potentially exceeding 300,000. Such a result could have a significant effect on investors. So far, the market has been fairly complacent, anticipating only one more rate hike. However, Moya warns that a 2-year rate above 5% signifies a shift towards a “higher-for-longer” theme on rates. Should the economy continue to demonstrate strength, the Federal Reserve may find itself obligated to implement additional rate hikes.
Concerns Surrounding Stock Market Performance
Moya also expressed concerns regarding the stock market’s performance. He attributes this year’s surprising success to just seven stocks, indicating that market breadth may start to suffer. If the Federal Reserve proceeds with raising rates, Moya anticipates an expedited downturn. He argues that conquering inflation is crucial for a thriving real economy. However, he predicts rough waters ahead in the face of this endeavor.
Unintended Consequences of Rising Interest Rates
Interestingly, the Federal Reserve’s efforts to tighten financial conditions and control the economy may inadvertently backfire. Higher interest rates are currently benefiting savers in the form of increased income. This group has the advantage of reaping these benefits first, while borrowers are subjected to a delayed and negative impact. Economists highlight that due to the Covid-19 pandemic, individuals have been able to save more money. Consequently, many Americans now have the option to utilize their interest income toward paying off debt, spending, investing, or further accumulating cash reserves to generate even more interest.
The Growing Importance of Interest Income
Judith Raneri, a portfolio manager at Gabelli Funds in Rye, New York, also attests to the significance of interest rates. She manages the $3.6 billion Gabelli U.S. Treasury Money Market Fund and asserts that higher rates have been instrumental in helping investors generate substantial returns. This income can be utilized to pay off debt or continue growing through increased interest on an expanding cash reserve. As interest income plays a more prominent role in investors’ bottom lines, its impact extends across the economy, which is contrary to the Federal Reserve’s intention of slowing down the economy.
In conclusion, the potential effects of job gains and rising interest rates are important considerations for investors and the economy as a whole. Moya and Raneri shed light on the challenges and opportunities that lie ahead.
Federal Reserve’s Focus on Inflation Target
As the Federal Reserve (Fed) remains steadfast in its commitment to reaching its 2% inflation target, experts believe that the central bank will continue to raise interest rates. Michael Raneri, an economist, suggests that the Fed will opt for a 25 basis point increase in July followed by another 25 basis point increase in September.
Raneri highlights the latest ADP report, which further reinforces the robustness of the labor market. This report serves as a reminder of the Fed’s ongoing determination to pursue higher interest rates until any negative impact on the economy becomes apparent due to a softening labor market.
The primary objective for the Fed at present is reducing inflation levels, with no indication of a broader focus. While the central bank maintains its laser focus on this target, experts anticipate further interest rate hikes in the near future.
