Halyard’s Weekly Wrap – 08/05/22

Jobs! Jobs! Jobs!

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.

An inverted yield curve is usually a precursor to a recession, and in this case, coming contemporaneously with the second consecutive quarter of negative GDP.  The logic is that Fed rate hikes will cool the economy and drive inflation, and real interest rates lower, so investors should lock in long rates now before they fall.  The problem is that real rates are deeply negative, and the Fed is in the early innings of tightening monetary policy.  Our expectation was that economic growth would continue to decelerate through August and into the late September FOMC meeting, and that the Fed would decide to modify their rate hike trajectory and perhaps decrease the magnitude of rate hikes to 50 or 25 basis points.  With this morning’s employment report, the Fed has a firm case for another 75 basis points, and they could justifiably do it today.

The capital market’s reaction to the report was mixed, with the S&P 500 marginally higher versus last Friday’s close, and the U.S. dollar gaining versus the Euro, Pound, and Yen.  The steadily rising dollar has repeated been blamed for earning misses as second quarter earnings continue to trickle in.  For the week, the long bond was unchanged versus last Friday closing price, but that masked a four-point intraweek swing.

All eyes will be on the inflation measures next week, with consensus looking for year-over-year CPI to slip to 8.7%.  We’ll also be anxiously watching the small business index on Monday and the University of Michigan surveys on Friday for real-time clues of economic sentiment.  Both have fallen steadily since early this year and have yet to find a bottom, indicating that consumer sentiment continues to deteriorate.