This is exactly the kind of time when ○○ [Shun Nakahara's Word of the Day] Updated August 8
The market is in summer vacation mode, but...
Indicators suggesting a recovery in the U.S. economy, or the sustained strength of the economy, have been rolling in. Among them, the employment data was strong in every sense. According to the U.S. Labor Department, nonfarm payrolls in July increased by 528,000 from June. The gains surpassed all market expectations. The unemployment rate fell to 3.5%, the lowest in about 50 years. Wage growth accelerated. Why are these “economic indicators” so spotlighted? Because Federal Reserve Chair Jerome Powell, in a press conference, abandoned forward guidance and explained that future rate hikes will be data-dependent and decided on a meeting-by-meeting basis. Although the July CPI to be released on August 10 is a lagging indicator, it is certain to stay at a high level.
However, the difference this time is that leading indicators have all exceeded forecasts. The ISM Manufacturing PMI held at 52.8, and manufacturing prices fell from the forecast 74.3 to 60.0. The economy appears to be improving, and prices are falling—so that would be the scenario. Oil inventories are building, and ISM Non-Manufacturing Index also rose from the consensus 53.5 to 56.7, contrary to expectations.ISM Non-Manufacturing Index also rose from the consensus of 53.5 to 56.7, contrary to expectations.M Non-Manufacturing Index also rose from the consensus of 53.5 to 56.7, contrary to expectations.
Nevertheless, the employment data was exceptionally strong, with NFPR well above consensus by more than double at +471 thousand, hourly wages up 0.5%, year-over-year +5.2%, and the unemployment rate falling to 3.5%. While wage growth not accelerating inflation is an issue, it at least isn’t rising enough to stoke inflation.
Yet, it is clear from the indicators that commodity prices are falling and supply chains are improving.
On the 5th, in the U.S. financial markets, following July’s employment report, near-term Treasury yields surged. A 0.5% rate hike was the majority view, but after the employment data, the view reversed, and now 68% expect a 0.75% hike. The consensus for the terminal rate has shifted, with expectations that the final rate could be above 3.6%.
Honestly, it feels less like a set of economic indicators and more like a position-rebalancing and stop-loss effect. In the near term, the 10-year Treasury yield range could be neutral at around 2.75% to 3.25%, or perhaps a strong tightening zone of 3.5–3.75% would not be surprising. However, if the writer’s scenario of a clear U.S. economy slowdown starting in 2023 proves correct, it should slip back toward around 3% by year-end. Still, the recession scenario had clearly overshot; many funds and institutional investors bet too heavily on inflation accelerating, so the losses required time to realize.
At this point, neutrality or a mild economic recovery scenario is probably already in place. And this scenario is likely to be betrayed as well.
Even if consumption slows, it will first affect the lower-income groups, while higher-income groups continue to indulge somewhat. This summer—the vacation season—will be somewhat lively. Travel demand is strong due to the stress of a long period of confinement, and consumption will rise accordingly. Gasoline prices are stabilizing, corporate earnings are not falling sharply, albeit in a patchy manner. It feels like a temporary rebound during a warm spell, and indeed the third and fourth quarters are likely to show some positive economic growth. However, it should not exceed about 5% and will likely settle around 1–3%, resulting in a temporary rise before the economy’s decline. The market is currently pricing in a gradual continuation of such mild growth for about a year. It won’t be this simple, and there are signs the market is heading in the wrong direction here as well.
Still, market psychology has swung to extremes, and it may take some time for it to revert to neutral. Junk bond spreads have stopped widening, and rate-hike probabilities seem likely to oscillate around 0.50–0.75% for the time being.
Moreover, market participation is thinning. Fewer participants often lead to sudden, dramatic events, but many market participants do not think so. Market participants are human, and after three years of travel and outings being restricted, they want to enjoy traveling and going out. Considering this, the decrease in event risk is indeed likely. After all, everyone is on summer vacation. People want to relax at least during summer vacation, and in reality, no one will move—surely, said many fund managers who suffered significant losses in the first half, and Chair Powell of the Fed who failed last year, will think this way.
However, the market is ironic: after everyone stops moving and most market participants disappear, unexpected events can occur. Do not let your guard down during the summer holidays—keep it in mind.
