After Federal Reserve Chairman Powell last week reaffirmed his plans to keep raising interest rates to reduce inflation despite the risk of a recession, Friday’s monthly US jobs report could once again bring risks to the stock market, Tom Esaye said. former Merrill Lynch trader and founder of the Sevens Report newsletter.
The Labor Department’s monthly jobs report on Friday, which tracks employment in the public and private sectors, is expected to show the U.S. economy added 318,000 jobs in August, far fewer than the 528,000 jobs created in July, according to a survey of economists by The Wall Street Journal. The unemployment rate is seen holding steady at 3.5%, while average hourly earnings are expected to rise 0.4%, following a 0.5% increase in the previous month.
“The labor market needs to show signs that it is on its way back to a state of relative balance where job vacancies are about the same as the number of people looking for work – and if it doesn’t, then fears of a more dire- for a long time the Fed will be hiking and that is not good for stocks,” Essaye wrote in a note on Thursday.
According to Essaye, if employment results prove “too hot” with non-farm payrolls rising more than 350,000 for the month and the jobless rate falls below 3.5%, stocks will fall sharply in what could be “more -slightly intense repeat’ of last Friday as markets priced higher interest rates for longer.
US stocks tumbled last Friday, with the Dow Jones Industrial Average
closing more than 1000 points for its worst daily rate drop in three months after Chairman Powell said in his Jackson Hole address that the central bank would continue its fight to return the annual rate of inflation to the 2% target “until the job is done.”
“Such strong numbers would highlight that the labor market remains out of balance, and that would prompt the Fed to focus on slowing demand through higher rates,” Esaye said. “In effect, this would increase the chances of the ‘terminal’ fed funds rate moving above 4% and hopes of a rate cut in 2023 would likely be dashed.”
It expects the yield curve spread between The 10-year and 2-year government bonds to rise as the 2-year yield shoots higher on the prospect of higher rates, while the 10-year yield is also likely to rise, but less so.
The yield on 2-year government bonds hit a new 15-year high
at 3.528% on Thursday, while the 10-year Treasury yield
rose to 3.266%, its highest level since late June.
However, if job growth falls to a range of zero to 300,000 while the unemployment rate rises above 3.7%, the stock market can expect a modest rally given the decline in stocks over the past five days, according to Essaye.
retreated 22 points, or less than 0.1%, to 31,488. The S&P 500
lost 23 points, or 0.6%, to 3932. The Nasdaq Composite
fell 179 points, or 1.5%, to trade at 11,637. On a week-to-date basis, the Dow is down 2.8%, while the S&P 500 is down 3.6% and the Nasdaq has lost 4 .8%, according to Dow Jones market data.
“We wouldn’t expect an explosion higher in stock prices as the ‘Just Right’ jobs report will not yet bring back the idea of an imminent Fed reversal,” Esaye said. “(It) won’t make the Fed more dovish and keep alive the hope that the Fed might cut rates in 2023.”
In a worst-case scenario of negative jobs for August and a jump in the unemployment rate, stocks could rise on the “bad is good” sentiment, although the Fed won’t budge from tightening as the “soft number will” t changes the Fed’s calculation for the next few meetings — “we’re still getting 50-75 basis points into September, so we wouldn’t be inclined to chase that rally,” according to Essaye.