Zip-zap. That’s how fast Wall Street on Friday put aside fears of a stagnant economy and high inflation after a sizzling jobs report for July overshadowed concerns of a shrinking U.S. economy on the brink of a recession.
The worry instead turned to what a rip-roaring labor market and surging costs for everything means for stocks and bond portfolios, particularly if it turns into a mix of higher growth and inflation with staying power.
What to even call such a scenario? “Boomflation,” said Kent Engelke, chief economic strategist at Capitol Securities Management, pointing to yearly wage gains pegged at 5.2% on Friday, which should help fuel growth.
On the gloomier side, however, sits inflation at a 41-year high as of June, which may be even harder to tame after more workers in July dropped out of the labor pool.
“In the more immediate term, this directly challenges the view that the Fed is going to be done increasing rates when it gets the policy rate above 3%,” Engelke said by phone, adding that he suspects the end target now sits closer to 4%.
The surprisingly robust jobs report puts next Wednesday’s consumer-price index update for July into sharper focus, with many on Wall Street hoping for signs that inflation finally may be peaking.
“It’s good from the consumer perspective,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management of the jobs report, adding that many households have been struggling. “Even with strong wage gains, on average inflation has been higher,” he said.
“The challenge is that it makes the Fed’s task in bring down inflation harder.”
The bottom doesn’t quite feel like it’s falling out of the U.S. economy, but assets, from stocks to bond to cryptocurrencies, all endured nothing short of a shellacking in the year’s first half. What happens next?
“Stagflation fears, that’s kind of falling away,” said Dec Mullarkey, managing director of investment strategy and asset allocation at SLC Management.
He also thinks recession concerns have been a bit overblown, particularly with second-quarter corporate earnings coming in relatively strong. “Equity markets have been seeing that, and have been holding the line,” he said. “Everybody has been calling this a bear-market bounce. I haven’t been in that camp.”
Instead, Mullarkey said he’s bullish on both stocks and bonds, particularly when you can get relatively low-risk exposure to the U.S. investment-grade corporate bond market at a yield of about 4.3%.
While short-term Treasury rates have been “whipsawing around,” he also likes the increased stability seen in 30-year yields TMUBMUSD30Y,
“We do like a balanced approach,” said BMO’s Ma. “To the extent that there could be more challenges in equities, fixed-income provides more of a support than it did in the first half of the year.”
But Ma also said there will be “huge, huge focus” on Wednesday’s CPI reading for signs of recalcitrant inflation. “Especially in light of the jobs report, if both point to inflation that’s more sticky, it’s possible the narrative will change, where the Fed ultimately is going to have to take interest rates higher.”
Aggressive Fed rate-hikes since March already pushed the fed-funds rate to a 2.25% to 2.5% range, with more jumbo rate increases now likely.
Read: July jobs number has traders penciling in another jumbo Fed rate hike
Higher wages can pinch corporate profits, although households earn more to offset surging prices for gas, groceries, cars and housing. A stronger labor market eases recession fears. But the Federal Reserve’s inflation fight just got tougher.
What if it boils down to a certain level of boomflation is tolerable in the U.S., given all the strings pulled by the government during the pandemic to prevent households from losing their homes and to keep the economy from crashing into a deep, long recession?
“It really comes back to, can the world live with 5% wage increases,” Mullarkey said, adding that a lot of the wage gains have been for workers with lower-level incomes. “That could be a healthy catch-up that’s merited.”
On worker shortages, he also said it isn’t accurate to blame older workers who have been retiring. “We are short 2 million workers that would have been coming in from overseas,” Mullarkey said, pointing to immigration restrictions rolled out under the past administration. “That’s put a hole in our workforce.”
Another approach might be for the Fed to consider abandoning its idea that a 2% annual rate of inflation is a “neutral” target.
“What sounds like a Fed commitment to get to 2% inflation is a tough number to get to,” Ma at BMO said, adding that it also risks the central bank “overtightening, by seeing no easy way to bring down inflation other than slowing the economy more than people would probably like to see it slow down.”
On the other hand, from an economic and markets standpoint, “it’s fine to have a little bit higher range of 2% to 3% because of the sticker points of inflation and the tightness of the labor market,” he said. “There’s nothing magical about 2%.”
Although, he doesn’t think the mind-set, at the Fed, is there yet.
Other economic data on tap for the week ahead is the New York Fed’s 3-year inflation expectations, followed Tuesday by the NFIB small-business index. Then it is Wednesday’s important CPI gauge for July, and Friday’s consumer sentiment reading.
U.S. stocks were trading higher Monday, with the Dow Jones Industrial Average DJIA,
Related: ‘One of the strongest job markets in the past 50 years’: Looking for a pay raise? This jobs report has good news for you.
European stocks slumped, the euro fell and natural gas skyrocketed after Russia said it was cutting off gas supplies through the Nord Stream 1 pipeline indefinitely.
Joy Wiltermuth is a news editor and senior markets reporter based in San Francisco.
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