In the strange world of navigating financial markets, sometimes good news can be bad, and bad news can be good. This was the case earlier in the year when inflation was surprising to the upside and fanning fears of economic overheating. Back then, bad news in the form of economic data that missed relative to expectations was interpreted as “good,” since it meant that the economy was beginning to cool enough to allow inflation to resume normalizing lower, which it has. Fast forward a few months after further progress on inflation and a spate of weak data recently, and it’s clear that we’ve suddenly shifted back to a situation where bad news is taken at face value…as bad news. This morning’s miss on the monthly jobs report with only 114k jobs created last month compared to expectations of 175k is feeding into a new market narrative that the Fed is falling behind the curve on lowering interest rates, and may have even made a policy mistake by presumably waiting until their next meeting in September to get started instead of taking the opportunity on Wednesday. This has led to a sharp uptick in volatility with stocks selling off and bond yields plunging.
Bigger picture, the economy is cooling, which by definition is a necessary component on a path towards a soft landing. The dangerous high wire act all along for a Fed that’s been determined to keep rates “higher for longer” to win the battle on inflation has been to not keep them “too high for too long” and accidentally damage the economy in the process. So far, the economy has appeared to be on the soft landing path – GDP growth in the first half of the year was roughly 2%, which is a step down from last year but certainly not recessionary. And while it’s still early in Q3, tracking estimates show that growth is currently around 2.5%. However, this morning’s payroll miss is a warning shot across the bow that the Fed needs to be far more attentive to the labor side of their mandate moving forward, and that downside risks to the economy are building the longer they wait.
For now, markets may remain volatile particularly if more bad news arrives over the summer in the form of additional signs of economic weakness. Expect interim comments and speeches from various Fed officials to turn more soothing until we get to the next meeting in September and are provided more clarity on their rate cutting intentions going forward. In the meantime, the good news for investors in balanced portfolios is that unlike 2022 when inflation was raging, traditional bonds are back to playing their usual role as portfolio diversifiers when concerns about growth start to surface – with market-based interest rates dropping across the yield curve, it’s giving a boost to bond prices and helping to dampen some of the equity volatility.
Source: Bloomberg, as of 8/2/24
Source: Koyfin, as of 8/2/24
Carl Noble, CFA
Senior Vice President of Investments
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