Stocks rolled over again on Friday, pushing the Dow Jones Industrial Average to its weakest weekly close since April 2014.
This came on a drop in the unemployment rate to 5.1% in August, which increased the odds of a Federal Reserve interest rate hike at its Sept. 17 policy announcement. If it happens, it would be the first interest rate policy increase since 2006.
In the end, the Dow Jones Industrial Average lost 1.7%, the S&P 500 Index lost 1.5%, the Nasdaq Composite lost 1.1% and the Russell 2000 lost 0.8%.
The selling pressure started overnight with Japan’s Nikkei Average losing 2.2% to close at levels not seen since February. Crude oil lost 1.5% to close at $46.06 a barrel, while gold lost 0.3% to close at $1121.50.
With the Dow Jones bonking its head on resistance from the 38% retracement level, the Aug. 24’s “Black Monday” lows should be exceeded in the coming weeks, as the market tries to scare the Fed out of tightening monetary policy.
Friday’s jobs numbers increased the odds of a September rate hike, as set by the futures market, to around 35%. For now, based on comments from Fed officials, market participants believe recent stock market turmoil will keep interest rates near zero.
Whether that’s true depends on how Fed chairman Janet Yellen and her cohorts interpret the latest read on the labor market. While the unemployment rate dropped to a level not seen since April 2008, only 173,000 jobs were created, well below the consensus forecast for 223,000. This result was also below the five-month average of 211,000 and the previous six-month average of 282,000.
Clearly, the job market has lost a little of its verve.
Offsetting this, however, was strong wage growth, as average hourly earnings were up 30 basis points, bringing the year-over-year rate to 2.2%.
If the Fed does decide to postpone its planned rate liftoff, it will truly enter uncharted territory.
Coming out of the 1990-1991 recession, rate hikes started with the unemployment rate at 6.6%. Coming out of the 2001 recession, rate hikes started with the unemployment rate at 5.6%. Today, with the jobless rate at 5.1%, Wall Street doesn’t believe Yellen will take action.
Which begs the question — why are stocks falling?
It’s a little like the chicken and the egg: Traders are worried about end of zero interest rates — which have been in place since 2008 — now that the jobless rate has hit the Fed’s median estimate of the “full employment.” In other words, by at least one metric the job market has finally fully healed from the recession.
Yet, along with still soft inflation measures, Fed officials are worried about the impact a rate hike will have on market stability. With stocks nervous, the Fed may well decide to hold off until its October or December policy meetings, kicking the can on policy normalization one more time.
Strangely enough, the current market selloff could set the stage for a strong “no hike” rebound later this month, only to face the threat of higher rates again in October or December with frazzled nerves.
Wall Street economists are doing their best to explain this twisted logic to clients. Consider this research excerpt from Bank of America Merrill Lynch:
“In our view, this report clearly shows ‘some’ further improvement in the labor market, leaving the Fed comfortable starting the hiking cycle in September. We therefore are holding to our call that the Fed will hike on the 17th, but be sure to emphasis the gradual nature of the cycle … However, the market has to cooperate; they don’t want to hike in the face of significant turmoil. Our baseline call for September remains, but we acknowledge the risks of a ‘tactical’ delay to October or December.”
Put simply, no one really knows where the Fed will take interest rates later this month. But the nagging fear is that they take them higher — adding to headwinds such as the turmoil in China, slowdown in corporate profits and a growing sense that cheap money stimulus has lost its potency.
That’s created short-side opportunities, such as the move lower in Bank of America Corp (NYSE:BAC) that has pushed the September $16.50 puts to a gain of roughly 80% since recommended to Edge Pro subscribers on Aug. 28.
With U.S. markets closed on Monday for Labor Day, all eyes will be on China as it reopens after the holiday closure.
Data on trade flows and inflation, too, will be closely watched for indications of an ongoing economic slide in the Middle Kingdom.
On Wednesday, the product unveiling event by Apple Inc (NASDAQ:AAPL) is expected to feature the debut of Tim Cook’s new iPhone and iPad lineup, which will hopefully be enough to turn the stock around.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
