U.S. equities rallied on Friday and broke out of their recent funk thanks to a solid, way-above-consensus gain in July payrolls. This marked the second straight month of solid gains after a disappointing jobs report for May.
And after tepid pace of GDP growth in the first half of the year, this is alleviating concerns about the health of the consumer. But amid evidence inflation is firming, the result also greatly increases the odds the Federal Reserve will hike interest rates again before the end of the year.
In the end, the Dow Jones Industrial Average gained 1%, the S&P 500 Index gained 0.9%, the Nasdaq Composite gained 1.1% and the Russell 2000 gained 1.4%. Treasury bonds weakened, the dollar was stronger, gold lost 1.6% on higher odds of a Fed rate hike and oil fell after a two-day rally, down 0.3%.
Eight of the ten major sectors finished higher with financials leading the way on an increase in long-term yields with a gain of 1.9%. Technology followed with a 1.2% gain. Defensive, yield-sensitive utilities and telecom stocks were the laggards down 1.4% and 0.2%, respectively.
Rackspace Hosting, Inc. (NYSE:RAX) gained another 10.2% after reports the company is in advanced talked to be purchased for more than $3.5 billion. RAX gained 14.5% on Thursday. Priceline Group Inc (NASDAQ:PCLN) gained 4% on a Q2 earnings beat. Bristol-Myers Squibb (NYSE:BMY) was slammed 16% after announcing that a phase III study investigating Opdivo for non-small-cell lung cancer did not meet expectations.
Technically, as shown above, Friday’s gains merely took stocks back to the upper end of their super-tight July trading range. Status quo, for now.
Back to the jobs report: The economy created 255,000 jobs in July vs. the 185,000 estimated. The unemployment rate held at 4.9% as well.
This is good news in that it bolsters the U.S. consumer at a time when shoppers are all that stands between the economy and a new recession based on the outright contraction in non-consumer activity. Separately, the Federal Reserve Bank of Atlanta boosted their third quarter estimate of GDP growth to 3.8%, a marked acceleration from the tepid pace seen in the first half of the year.
But what’s for the economy and consumers could be bad news for the liquidity junkies in the market since it increases the odds the Federal Reserve will stick to its two-quarter-point rate hike forecast for this year from June.
For now, the market is taking the specter of higher interest rates in stride. According to the futures market, odds of a September rate hike have doubled to 18% while odds of at least a single rate hike by December have increased to nearly 40%.
Traders believe there is only a 6.7% chance the Fed hikes rates twice this year. Translation: Despite core inflation above the Fed’s 2% target and rising, and job growth solid, it’s hard to believe the Fed will turn hawkish now after years of coming up with new excuses to delay rate hikes. From Brexit to worries about China and even concern about the performance of the U.S. stock market have all been used to justify the Fed’s persistent dovishness.
But a few more months like this will make further delays a direct risk to the credibility of the central bank and could result in an undesirable rise in long-term interest rates as bond traders price in runaway inflation pressure.
Solid job growth, along with evidence inflation is firming (mainly, due to housing costs), makes the case for delaying further interest rate normalization increasingly difficult. Especially after the much-maligned “Brexit” vote from June turned into a very short-lived tempest.
Federal Reserve Board Chair Janet Yellen could hike rates, which would upset stocks and the corporate market as well as worsen the corporate earnings recession by boosting the dollar and weakening oil prices; or she could find an excuse to delay, which would boost stocks but could unleash turmoil in the T-bond market as long-term yields increase anyway on higher inflation expectations.
Wall Street’s Fed obsession is going to become even more unbearable in the weeks to come, with Yellen speaking at the Jackson Hole symposium on Aug. 26.
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.
