If you are confused about what to worry about, join the club. One day the market freaks out about the recession that we are meant to be either in or is coming up quickly. The next day growth is too strong and inflation is the fear du jour. Just look at the performance of long-term Treasury bonds this week – the numbers below show the price change in the iShares 20+ Treasury Bond ETF (TLT).
This is a portfolio of government bonds that is trading like a meme stock. What accounts for the back-and-forth?
Something for Everyone
No Recession = Inflation Will Be Sticky
For those in the no recession camp the monthly report on services gave you something to chew on. The ISM Services index posted a solid positive surprise for July, coming in at 56.7 after two months of contraction (chart below). Anything above 50 indicates a growing sector and argues against recession.
It was the same story for the ISM manufacturing report. Despite a lot of talk about manufacturing being in recession, the index came in at 52.8, down just 0.2 from the previous month.
Inflation Has Peaked
Conversely, these same reports hinted that inflation might have peaked. Both the ISM services and manufacturing reports contain an assessment of prices paid in each sector. Both measures moderated notably. First, prices paid in the service sector fell to 72.3, the lowest level since February 2021, from 80.1 (chart below).
Same story in the manufacturing sectors. Prices paid fell from 78.5 to 60.0 (green line below) – the fourth largest fall since 1948!!!
Whoa – Not So Fast With That Inflation Call!!
The ISM data had something of a Goldilocks smell to it – decent growth, moderating price pressures…what’s not to like?
Well, Friday’s payrolls report put the cat among the pigeons as they say. Economists were expecting payroll growth of 250K (the median estimate shown below). And if anything, people were leaning towards a lower number. The top ranked economists were coming in at around 200K. And I’m not sure a negative number would really have been that surprising given all the recession chatter lately.
So, what was the final number? Oh, just 528K – more than double consensus – and a major acceleration from the last four months, as you can see below.
We also hit an important threshold – the U.S. economy has now recouped all the jobs lost during the COVID crisis.
The Fed is Likely to Keep on Keeping On
There’s a bit of a ‘good news is bad’ dynamic going on, at least for the bond markets. Before Friday the prevailing view was that the Fed might be able to go easy after the next meeting. Yea, we’d probably see a half-point hike on September 21st, but that could be it for a while.
Well, Friday’s payrolls report shifted expectations significantly. Now a 75bps hike looks more likely in September, with another 75bps starting to be priced in for the November meeting. The chart below shows the odds of both a 50bps and 75bps hike in September.
J.P. Morgan’s note today captures the general view:
“For the Fed, we continue to look for two more 25bp hikes in November and December, bringing the terminal rate to 3.5-3.75%. Unless the data stumble, a case could be made for going more than 75bp at the next meeting, though if the FOMC rejected that option in June and July it would seem they have an aversion to ripping off the bandage. So far they also seem averse to hiking inter-meeting.”
The point here isn’t so much the details, but just how wildly expectations can swing. A week ago we were talking about recession, now we are back to debating large rate hikes. The only consistent theme is that the yield curve inversion gets deeper and deeper. As we write it stands at -41bps. You have to go back to 2000 to find a comparable number.
Bond volatility is unlikely to disappear next week. We get the CPI report for July on Wednesday – maybe the streak of 2% bond market swings will continue!!
Charts We Found Interesting
1. For all the talk about the Fed shrinking their balance sheet, they haven’t done much yet.
2. What’s more important for inflation going forward – the growth in the money supply or the total dollars outstanding?
3. Mortgage rates fell below 5% for the first time since April.
4. One overlooked factor for why growth struggled in the first half of this year is the big contraction in the Federal budget deficit.
5. It’s been a tough few years for emerging market equities.
6. An ugly chart for European energy consumers.
7. Europe increased its imports of Russian diesel by more than a fifth in July. The region imported almost 700,000 barrels a day of the fuel from Russia last month, a 22% increase compared with July last year.
8. Land use and food production.
Have a good weekend.
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