They say that markets don’t like surprises. How then do we rationalize the market’s enthusiastic response to what would appear to be a surprise of the nastiest kind?
I was aghast to see that non-farm payrolls rose by 278,000 versus an expected 1 million increase. That is a staggering miss by the economists surveyed – reported to be the largest payroll miss ever. Equity investors have been pricing in a robust post-pandemic recovery, and today’s payroll number was expected to be another milestone on that path. Not so fast, it seems.
The bond market made its move first, with 10-year yields dropping nearly 10 basis points almost immediately. It took a few seconds, but equity futures began rising in response, with most of the rally coming in NQ, the NASDAQ 100 E-Mini. I believe that this response was triggered algorithmically. Since bond yields began to rise early this year, we have seen the NASDAQ 100 (NDX) and the mega-cap tech stocks that comprise the majority of that index respond inversely to bond yields. In theory, higher yields reduce the present value of those stocks’ future cash flows and their lofty valuations. In practice, the valuations remained lofty regardless, but remember that algorithms react to (and sometimes amplify) tradeable relationships. Besides, we have seen markets rally on seemingly bad news before.
Even though bonds gave back about ¾ of their basis point improvement, stocks continued to rally regardless. The narrative changed immediately to “this keeps the Fed on the sidelines”. Remember that Chairman Powell and various Fed governors have been adamant about asserting that the FOMC is not inclined to reduce monetary accommodation until or unless the economy reverts to full employment and sustainable 2% inflation. Today’s payrolls miss certainly appears to push back the timing of full employment, thus keeping the monetary accommodation in place.
This is the key. Above and beyond all else, equity markets are addicted to central bank liquidity. It is quaint to think in terms of stock valuations, economic strength, and the like, but ultimately they are all pale in importance to easy money. Investors have been conditioned for decades not to fight the Fed. Somewhere along the way that morphed into slavishly following the Fed as well.
That said, this number was not a slam-dunk for a more accommodative Fed. Along with the missed non-farm payrolls statistic, economists also botched their estimate for average hourly earnings. The median estimate was for no change from the prior month, but instead we saw a 0.7% rise. Somehow, we saw fewer people hired, but it seems that those who were hired demanded and received higher wages. If we combine the ideas that labor costs may be rising along with the obvious increases in commodity prices, it is not difficult to consider that inflationary pressures may be spilling into the economy at a quicker pace than investors are anticipating.
My immediate comment upon seeing this morning’s statistics was “stagflation.” That term refers to a stagnating economy with rising inflation. Today’s numbers still reflected a growing economy – the payrolls increase would have been greeted warmly prior to the pandemic – but we must consider whether the economy is keeping pace with inflation. Inflation is a monetary phenomenon, when more dollars are required to purchase the same amount of goods and services. We have been seeing that more money is required to buy a fixed amount of commodities, now it appears that at least last month we saw that more money was required to purchase an hour of labor.
One month does not make a trend, and it will be fascinating to listen to the debates that will arise over the coming weeks regarding Fed policy, labor markets, and inflation. If inflationary pressures continue, will the Fed be able continue to retain its commitment to full employment? The gold market may be providing a clue, as gold has begun to follow commodity prices once again after being primarily focused on movements in the dollar.
For now, the economists were wrong, and the markets got what they really wanted anyway – a path to more easy money. Let’s see where that path takes us.
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