Softer Economy = Lower Inflation

Stocks popped at the open (Dow +700 pts; SPX +2.6%) today. The VIX fear gauge fell back under 30, the dollar is finally weakening a bit, and commodities are roaring back in early trading. WTI crude oil bounced from $79/barrel to $86/barrel over the last two days as OPEC considers production cuts. Yesterday’s stock rally was directly related to falling bond yields—the S&P 500 climbed 2.6% as the 2-year Treasury yield dipped to 4.11% from 4.28%–and the story is largely the same today. The 2-year Treasury yield fell back to 4.09% this morning, relieving some pressure on stocks.

Oddly enough, another reason for this mini stock rally is weaker economic data. Specifically, we got some downbeat data on manufacturing business activity from research firms JP Morgan and ISM yesterday. JP Morgan’s Global Manufacturing PMI fell for a fourth straight month to 49.8 as international trade slowed. In addition, ISM released data for its US Manufacturing Index, which deteriorated to 50.9 from 52.8 with a clear drop-off in hiring activity, production, and new product orders. Both surveys use the same scale: 50.0 is the dividing line between contracting and expanding business activity. The clear takeaway is that manufacturing activity has stalled. But one more detail within the reports is just as critical: manufacturers reported lower input costs. Wholesale inflation is moderating.

Likewise, the Labor Department says US job openings fell unexpectedly to a 14-month low in August. The number of available job positions slid to 10.05 million from nearly 11.2 million in the prior month. This is clear evidence that the Fed’s tighter monetary policy is slowing the economy according to plan. Reducing labor demand to better match supply should begin to bring down wage inflation. Ideally, the Fed will accomplish this goal without causing a spike in unemployment. Bloomberg News attributed this report to today’s stock rally, explaining that “traders grew optimistic the Fed may not have to be as aggressive with its interest-rate hikes given some signs that demand for workers is cooling.”