US Economy Resilient – More Volatility Ahead For Markets

The stock market opened slightly lower this morning despite a positive ISM Services report (see below). At the moment, the Dow is down 85 points and the S&P 500 is off by about .15%. The VIX volatility gauge is up around 25; traders are betting on increased volatility over the next month. The bond market is selling off sharply, sending interest yields higher. Long-term Treasury bond prices are down about 2% and high-grade corporates are off 1%. Any hint of a resilient US economy is going to 1) drive traders out of safe-haven bonds and 2) feed fears that the Fed will have to worker harder to kill inflation. Yields are going higher.

The Institute for Supply Management’s survey of service-related businesses (“ISM Services”) improved unexpectedly in August. Current activity, new orders and even export orders improved during the month. Even better, the survey’s inflation gauge fell to a 19-month low. Supply chains are clearly healing. Hiring has stagnated somewhat, but that seems to be the result of limited supply of workers. Commenting on the report, Bloomberg Economist Eliza Winger says the “economy maintains strong underlying momentum,” proving it “can take aggressive [rate] hikes.”

Last Friday’s highly anticipated Employment Situation Report was sort of a non-event. Data confirmed some slowing in the red-hot labor market, but not enough to convince the Federal Reserve to pause interest rate hikes. The economy generated 315,000 net new jobs in August, right in line with expectations. The unemployment rate ticked up to 3.7%, primarily because more people re-joined the labor force. That’s good news. Wage growth moderated a bit, but was still 5.2% higher than a year ago. Interestingly, June payrolls were revised sharply lower than previously reported (to 283k from 398k), suggesting that investors were perhaps overestimating job growth coming into the summer. It seems to me that stock & bond traders had pinned their hopes on this report for some clarity on the health of the economy and the impact of monetary policy. It didn’t deliver, and because August payrolls tend to be seasonally volatile, we could see meaningful revisions to the numbers listed above.

OPEC is playing games with oil production again. The cartel announced a small cut in production aimed at arresting the recent slide in prices. Reducing production by 100k barrels per day is too small to really have an impact, but the group is signaling further cuts are probably soon to follow. WTI crude has fallen to $87/barrel from $120/barrel when Russia invaded Ukraine last winter. Of course, it never deserved to be at $120, and now that global economic growth is slowing $87/barrel might be too high. China just shut down another major city due to a minor Covid outbreak. And the Russia/Ukraine conflict is nowhere close to being resolved. Bloomberg News revealed a Russian government report predicting that its economy won’t claw back to pre-war levels for years.