Does July’s U.S. jobs report bolster the odds of another big Fed rate hike?

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben discussed the U.S. July jobs report, the latest rate hike by the Bank of England (BoE) and results from second-quarter earnings season.

Strong U.S. jobs report boosts case for large September rate increase

On 5 August, the U.S. Department of Labour released the nonfarm payrolls report for July, which showed that the nation added 528,000 jobs last month - more than double consensus expectations for a gain of 250,000, Ristuben said.

"This was a very strong number - in fact, July's job gains were the most since February. This really puts the idea that the U.S. job market is cooling and inflationary forces are dwindling in serious jeopardy," he stated. Ristuben noted that wage growth also came in hotter than expected, with average hourly wages in July rising 0.5% from June, compared to expectations for a 0.3% increase. On a year-over-year basis, wages climbed by 5.2% in July, topping consensus estimates of 4.9%, he added.

Ristuben said that ultimately, the July jobs report strengthens the case for another jumbo-sized rate hike by the U.S. Federal Reserve (Fed) at its 20-21 September meeting. "In my opinion, the Fed will probably lift rates by 75 basis points (bps) again in September, unless something dramatic happens between now and then," he stated. There are only three major economic data releases before the next Fed meeting, Ristuben noted: the July and August consumer price index (CPI) reports and the August employment report.

He added that in the wake of July's red-hot jobs numbers, the U.S. Treasury yield-curve inversion steepened, with investors selling shorter-dated bonds in favour of longer-dated bonds. "What's good news for the economy is often bad news for markets - and with these latest moves, the bond market is essentially saying that the odds of Fed tightening leading to a recession have gone up," Ristuben remarked.

BoE doubles down on inflation fight with 50-bps rate hike

Shifting to Europe, Ristuben noted that on 4 August, the BoE announced its largest rate increase since 1995, raising borrowing costs by 50 bps. The rate hike, the UK central bank's sixth in a row, takes the base rate to 1.75%, he remarked.

Ristuben said that the magnitude of the rate increase demonstrates just how serious the BoE is about squashing inflation, which hit a 40-year high of 9.4% in June. "Not only did the central bank lift interest rates by 0.5%, but it did so while predicting that the UK is about to slip into a long recession, beginning in the fourth quarter of this year," he stated. BoE officials are forecasting that the next UK recession will last for five straight quarters, or through the end of 2023, Ristuben explained.

"The BoE's latest move shows that, above all else, the central bank wants inflation extinguished, as its long-term effects can be much more significant than those caused by a recession. If inflation becomes entrenched in the economy, it can cause some real structural damage," he stated. Ristuben noted that the BoE's views on inflation are in alignment with most other major central banks, including the Fed, which has signalled it will fight inflation at all costs, even if a recession ensues.

He added that inflationary pressures in the UK have been further exacerbated by the Russia-Ukraine war, which has sent energy costs in the region soaring. "The energy crisis in Europe has become one of the key contributing factors to UK and European inflation, and the ongoing uncertainty around this probably places Europe closer to a recession than the U.S.," Ristuben remarked.

Is Q2 earnings season fuelling the rally in markets?

Transitioning to markets, Ristuben noted that major benchmarks have rallied considerably off their mid-June lows, with the MSCI All-Country World Index up approximately 10% since then, while the benchmark S&P 500® Index has risen roughly 14% in the same timeframe.

In his opinion, the bear market rally can be attributed to a few key factors, including U.S. second-quarter earnings. A little more than half of S&P 500 companies have reported results so far, and the numbers have largely been better than excepted, Ristuben said, characterising Q2 earnings as reasonably good.

Right now, the blended earnings growth rate for the second quarter is around 6%, versus consensus expectations heading into the reporting season of about 4%, he explained. "Simply put, we're not seeing devastation in corporate earnings yet, and I think this is giving the market some comfort," Ristuben observed.

He added that some of the rebound may also be due to the fact that nothing truly terrible happened to the U.S. economy during July, despite consumer sentiment hitting all-time lows in June. "Oddly enough, the fact that a worst-case scenario for the nation's economy didn't materialize in July has probably helped contribute to some of the rally," Ristuben concluded.