- Mixed labor market data shifted market sentiment.
- Central Bank mantra continues with “higher for longer,” and likely two more rate hikes by year-end.
- The manufacturing sector continues to struggle, while the service sector recovers.
Markets slipped in the first holiday-shortened week of July, with the TSX and the S&P 500 closing lower by 1.6% and 1.2%, respectively. Growth stocks outpaced value with the help of Tesla, which reported better-than-expected sales. Mixed labor market data surprised market participants, shifting sentiment and increasing expectations for the Fed and the Bank of Canada to raise rates later this month. Bond yields responded, pushing the U.S. 10-year Treasury back over 4% and the Canadian 10-year to 3.57%. European equities also struggled on fears that central banks would keep monetary policy tight for longer.
On Monday, the Institute for Supply Management’s manufacturing survey slid to 46% in June from 46.9% in May. The latest reading is the lowest reading since May 2020. Readings below 50 signal a contraction. The New Orders Index rose 3.0 points to 45.6% but remains solidly in contraction territory. The Production Index dropped 4.4 points to 46.7%, and the employment gauge fell 3.3 points to 48.1%. A sign that inflation is slowing, the prices index declined 2.7 points to 41.8%. The manufacturing side of the economy is responding to the decline in customer orders by reducing inventories and slowing production.1 On Friday, the ISM released the services sector survey. The services sector expanded for the sixth consecutive month, with the Business Activity Index jumping 7.7 points to 59.2 versus 51.5 in May. The New Orders Index rose 2.6 points to 55.5, and like the manufacturing sectors, the Prices Index in June fell 2.1 points to 54.1%. Fifteen of the sectors reported growth in June.2
On Wednesday, the Fed’s June FOMC meeting minutes were released, indicating some participants favored a 25-basis points hike. Officials favoring the hike indicated that there were few clear signs that inflation was returning to the 2% target. The “dot plot” forecast showed that FOMC members expected two more rate hikes by the end of the year.3 In a speech at a Central Bank Research Association meeting, the Dallas Fed President, Lorie Logan, set expectations that rates would remain higher for longer when she said she anticipated two more rate hikes by year’s end.4
Also on Wednesday, the ADP payroll report showed private sector employment in June increased by 497,000, beating the expectations by 220,000 of economists polled by The Wall Street Journal. The service sector alone added 373,000 jobs. Wage gains for those remaining with employers rose 6.4% year-over-year, which was slightly lower from 6.6% in May. For those changing jobs, pay increases slowed to 11.2%, the slowest since October 2021.5 On Friday, the U.S. Department of Labor reported that non-farm payroll employment increased by 209,000 in June, the smallest increase in more than two and a half years and less than the 240,000 expected by The Wall Street Journal poll of economists. The unemployment rate dropped to 3.6% from 3.7%. Wages grew by 0.4% in the month, and year-over-year wages increased by 4.4%. The government added 30% of the new jobs, and the private sector added just 149,000, with most in healthcare and private education.6
Canadian job growth for June increased by 60,000 (up by 0.3%) with increases in retail trade, manufacturing, healthcare and social assistance, transportation and warehousing. Declines occurred in construction, educational services and agriculture.7
On Thursday, the U.S. initial claims for unemployment benefits for the week, ending July 1, increased by 12,000 over the previous week to 248,000. Benefits for all programs for the week, ending June 16, were 1,699,565 – an increase of 1,775 from a week earlier.8
Investors want to believe the end is near and that central banks will reverse course and start reducing rates. While at the same time, central bank officials are continuing to stay “higher for longer” and future policy decisions are “data-dependent.” Equities are going to need earnings to support higher valuations. If rates move too high and remain elevated for too long, the coming recession will more severely impact earnings and current valuations. The balance between fighting inflation and growth is a fine line that, in the past, has been hard to navigate successfully. This week is a fine example of how data is causing investor sentiment to swing wildly, creating potential volatility in equities and bonds.
Sources:
1https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/pmi/may/
3https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20230614.pdf
4https://www.dallasfed.org/news/speeches/logan/2023/lkl230706
6https://www.bls.gov/news.release/pdf/empsit.pdf
7https://www150.statcan.gc.ca/n1/daily-quotidien/230707/dq230707a-eng.htm
8https://www.dol.gov/ui/data.pdf
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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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