QVMS - The Strong July Jobs Report Kills Any Hopes For The Doves

• The jobs report today was much stronger than expected.
• That's causing rates to rise significantly.
• Today's data likely kills any hopes for a dovish FOMC pivot.

Any hopes for a dovish Fed pivot were killed instantly today on the shockingly strong jobs report. In July, there were 528,000 created, more than double the estimates. On top of that, wages were much hotter than expected, coming in at 5.2% y/y and 0.5% m/m. The unemployment rate also dropped to 3.5% from 3.6% last month.

This data sent bond yields instantly higher, resulting in a repricing of Fed Fund futures. Fed Funds futures are now seeing rates rising as high as 3.66% by April of 2023, up from 3.42% yesterday.

The repricing also has sent rates higher across the Treasury curve, generally increasing by 15 to 20 bps. Generally speaking, ahead of this data, yields had moved to low as the market thought the Fed would ease back on the rate hikes due to slower growth. That was wrong - growth hasn't slowed at all .

It's clear now that rates must account for today's data and future rate hikes.

2-Year Rates

In fact, with the December 2022 Fed Futures contract now trading at 3.50%, it would not be surprising to see the 2-yr rate climb up to that 3.50% and potentially move higher than 3.5%. The 2-yr rate quickly reached a technical resistance level of 3.25%. If the rate should move above resistance, it seems likely that the 2-yr climbs to prior highs around 3.45% over the near term before potentially making a much larger move higher.

If the Fed's projections are correct, and the Fed Funds rate rises to 3.8% by the end of 2023, then a 2-yr rate going beyond 4% seems like a strong possibility, as there is very little if any technical resistance that is standing in the way of such an advance.

Dollar Strength

Of course, expectations of a more Hawkish Fed also are sending the dollar index sharply higher. More rate hikes by a Fed determined to bring inflation down means the dollar will need to strengthen further as the interest rate differential between the euro and yen widen. Additionally, the dollar is strengthening against the Chinese yuan due to a weakening Chinese economy.

The dollar index has seen solid bullish momentum for nearly two years and shows no sign of slowing down. The RSI has recently come down to its long-term uptrend. Additionally, a bullish break out of a technical continuation pattern known as a bull flag on the price chart could raise the dollar index to around 111.

Real Yields and Stocks

Of course, rising rates and a stronger dollar are also helping to pull real yields higher, with the 10-Yr TIP rate rising back to 37 bps. The rising real yield is sending the TIP ETF lower, which is very negative for stocks. The TIP ETF peaked on July 29 and Aug. 1, but the QQQ ETF continued to rise.

If the TIP ETF continues to drop, the [[QQQ]] ETF will follow the TIP ETF lower as real yields compress the Nasdaq's PE ratios.

The PE ratio has an inverse relationship with the earnings yield, and as real yields rise, they work to pull all yields higher - this includes an index's or stock's earnings yield. As the earnings yields rise due to rising real yields, the PE ratio of the Nasdaq gets pushed lower.

Because real yields are rising so sharply today, it makes the spread between the Nasdaq earnings yield and the 10-Yr TIP rate contract, which in turn means that the Nasdaq is getting more expensive vs. the 10-Yr TIP. For the Nasdaq's valuation to adjust, the spread needs to widen, which happens by the earnings yield of the Nasdaq rises, pushing the PE ratio down. The last few times, the spread reached around 3.3% - it widened back to 3.70%.

Importance of Today's Jobs

That's why today's job report is critical because it tells us the labor market is much stronger than expected. The reason for that strength is that despite two quarters of negative real GDP, growth in the economy's service sector is very strong. High prices are causing a negative GDP print, so the market's idea of demand destruction is wrong. The services side of the economy grew by 4.1% in the second quarter. The service's strength drives the demand for more workers and increases wages.

More Hikes

Ultimately the strong jobs market will push rates even higher than current values and keep the dollar index moving higher. The Fed will need to raise rates much more aggressively than the market had counted on. At some point, the Fed data dependency mode should lead to more volatility and a higher vix, pushing equity prices even lower. Because as today's data shows, the Fed may have to raise rates much more than the 50 basis points the market had been pricing in as the market shifts toward a 75 bps rate hike in September.

The market took the data dependency news from the FOMC meeting and assumed that the Fed would be forced to back off because there were two negative quarters of real GDP growth. That assumption was entirely wrong.

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