Last Friday’s US jobs report was hardly encouraging: the economy lost 23,000 jobs in July, with 53,000 fewer in the public sector and 30,000 more in the private sector, while previous months were revised down by 103,000.
The unemployment rate fell from 4.2% to 4.1%, but not because more people found jobs: the labor force participation rate fell to 61.4%, while the employment rate dropped to 58.9%.
So the economy is deteriorating, yet stocks are hitting new highs. Why?
Because the Fed has a dual mandate: 2% inflation and maximum employment. Its main tool is interest rates. When the economy weakens and people lose jobs, the Fed cuts rates to support growth, and vice versa.
So, after the weak jobs data, markets sharply cut the odds of a September hike, from nearly 60% to 46%.
Add strong earnings momentum, with 88% of the S&P 500 now reported, 86% beating earnings estimates and 76% beating revenue estimates, plus the US intervention to stabilize the yen, which temporarily eased Treasury liquidity concerns, and it is hardly surprising that the S&P 500 and Dow hit new highs.
Falling oil prices, on hopes of easing tensions in the Middle East, and increased traffic through the Strait of Hormuz might have helped too. The only problem is that, beyond the positive rhetoric, there is still no real progress toward ending the conflict.
The last piece of the puzzle is this week’s July inflation report. With headline CPI expected at 3.4% and core CPI at 2.5%, a core reading of 2.3% or lower would strengthen the case for a more dovish Fed, potentially pushing indices and gold higher.
It’s also worth watching Thursday’s producer prices and Friday’s retail sales, as well as preliminary University of Michigan consumer sentiment data. Remember, worse economic data would actually be better for markets right now.
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