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Santa rally cancelled?

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Yesterday we asked if Fed Chair Powell’s speech had opened the door to a stock market Santa Rally. Today’s strong employment data looks to have slammed that door shut. Stocks sold off aggressively. Is it game over for the bulls?


Compare and contrast the price action in the Nasdaq 100. The Post-Powell rally is on the left, and the initial NFP reaction on the right. There’s a lot to unpack in the report. First, context from the Fed’s perspective.

Inflation’s too high. It looks to have peaked for now, but the hard part for the Fed is bringing prices down to their 2% inflation (price stability) target. Ideally without crashing the economy.

The basic idea is to achieve this by raising interest rates and tightening financial conditions. The cost of debt servicing increases and begins to weigh on the economy. Aggregate demand falls, companies stop hiring, investing and look to cut costs (often by laying off employees). Everyone tightens their belts, spending slows, and it becomes harder to charge higher prices.

However, the labour market imbalance makes this a far longer process. Labour force participation (the number of available workers) has fallen since the pandemic. Companies aren’t so keen to cut staff as they would be if labour was abundant.

Due to the competition for workers and impact of inflation, workers are being granted larger pay rises instead.

One negative (from the Fed’s perspective at least) in today’s employment data was the news that Average Hourly Earnings had jumped by 0.6% in November. That’s well above the expected growth of 0.3%, and the previous figure of 0.4% (which was also revised higher to 0.5% today!)

If workers can keep demanding pay rises, companies will likely keep raising prices to compensate for the added expense. It’s a wage price spiral dynamic, although economists argue that workers don’t have enough power to maintain this indefinitely, mainly due to lower union membership.

As for companies stopping hiring, the non-farm payrolls figure came in at 263,000 jobs. The private payrolls data showed 221,000 new jobs. Both were well in excess of expectations. Today’s report showed a still strong labour market, higher wage growth and slightly lower labour force participation.

What does it mean for US stock markets?

There’s a theory that the stock market generally likes lower interest rates. When interest rates are low, it’s easier for businesses and individuals to borrow money, leading to increased consumer spending, which stimulates economic growth and company earnings growth.

Bulls are hoping that the Fed’s rate hikes can get inflation quickly under control, the economic damage is limited, and rates will come back down sooner.

Too many employment reports like this, and those hopes are likely to diminish. For now at least, the selloff looks to have stalled. The risks of even higher interest rates for 2023 loom large. The Fed will be silent from this weekend as they enter the pre-meeting blackout period, then it’s the double header. CPI on December 13th and the Fed decision (along with their quarterly economic and interest rate projections) the day after.

Not investment advice. Past performance does not guarantee or predict future performance.

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