The doldrums are finally upon us! Last Friday’s strong employment report assured worried investors that two straight quarters of economic contraction wouldn’t result in a “hard landing” and this week’s CPI offered hope that the inflation impulse has passed. With that, investors can relaxed and enjoy the last few weeks of summer.

The 0.00% monthly change in inflation was a welcome reprieve from what we’ve witnessed for nearly two years now. But we’re hesitant to declare victory in the Fed’s war on inflation. There’s still an enormous amount of excess liquidity in the system and the Fed’s quantitative tightening has been slow to drain the excess. The Fed’s reverse repo operation, the de facto add-on to the Treasury Bill market, totaled $2.199 trillion at Thursday’s operation, just a few billion below the peak reached earlier this year. And the T-Bill market itself continues to flash warning signs, with yield levels well below the overnight rate and bid/ask spreads of as much as 11 basis points, in some cases. Raising interest rates will slow some interest sensitive sectors, such as home and automobile sales, but the Fed needs to drain liquidity and they’ve barely scratched the surface.

We didn’t see that coming! On the back of the mixed June employment report, the July tally blew past all expectations. Coming in at 528,000 new jobs added, the report more than doubled the consensus expectation of 250,000 and exceeded the highest expectation of 325,000. Moreover, the details were equally eye popping, with average hourly earnings up 5.2%, year-over-year, and the unemployment rate ticking down to 3.5%, equaling the low touched on September 2019. The bond market didn’t like any of it. The yield curve that placidly drifted below 3% last week, convulsed back above that measure today. For the week, the 2-year note is 30 basis points higher, and the 2-year/30-year interest rate spread went negative for the second time this year, closing the week out decidedly inverted at -17 basis points.

From an economic perspective, this has been a terrible week; especially so for the housing sector. The NAHB housing index, housing starts, and existing home sales all plunged, as did mortgage applications. The earnings release from D.R. Horton, the home builder, beat expectations, but the company said that sales are expected to slow, and cancelations rise as buyers are experiencing “payment shock.” After falling a quarter point last week, the average 30-year mortgage rate ticked back up to 5.625%, giving pause to perspective buyers.

Fed Governor Chris Waller “tipped his cards” on Thursday regarding this morning’s employment report, saying the “Robust labor market” gave him confidence in the strength of the economy. The report showed that the economy added 372,000 new jobs in June, well ahead of the 265,000 that was expected. Given the anecdotal weakness we’ve been witnessing, our expectation was that the jobs figure would disappoint. His comment on jobs was in addition to him saying that he favored another 75- basis point hike later this month. That rate hike recommendation was echoed by St. Louis Fed President James Bullard, and both are voters on the rate decision committee.

As if the investing environment couldn’t be more challenging, this week only served to further muddy the water. Fed Chairman Powell testified before Congress in what was once referred to as the Humphrey-Hawkins testimony. The testimony is mandated twice a year and the Chairman is tasked with justifying his dual mandate of keeping unemployment and inflation low. His testimony was mostly comments Congressmen don’t want to hear. Namely, acknowledging that rising interest rates poses the risk of a recession, and that the employment market is running “too hot.” In the perverse thinking of bond investors that was good news. The logic goes that If the Fed Chairman is thinking that the coming rate hikes could result in a recession, then that means that inflation will be coming down faster than they had hoped and, therefore, rates will need to be cut sooner than anticipated. Taking their cue from bond investors, the stock jockeys interpreted that logic as a signal to buy, hence the 6% rise in the S&P 500 off the low touched last week. Notably, Powell didn’t say anything at the testimony that would indicate that the committee has changed their mind about raising rates another 75 basis points at the end of July.