The TSX hit new highs as U.S. jobs fell, and oil spiked
Why did markets rally on weak jobs data?
Consider what markets celebrated this week: the U.S. lost 23,000 jobs in July against expectations of 80,000 new jobs, with May and June revised down. July Consumer Price Index (CPI) data then came in at 3.4%, cooling for a second month. Stocks rose toward record levels.
The logic is simple and worth naming: weak jobs and tame inflation mean a September interest rate hike from the U.S. Federal Reserve (the Fed) is unlikely. Odds of a September hike fell from about 50% to roughly 35%, two-year Treasury yields (the interest rate on two-year U.S. government bonds) dropped to 4.14%, and stock valuations did the rest. The market is now trading on expectations of lower interest rates.
If you look closer at the inflation report, the relief is less than it appears on the surface. Gasoline is up 24.6% over the year, airfares are up 25.5%, and inflation at 3.4% still runs ahead of wage growth at 3.2%, which means the purchasing power of wages is shrinking. Cleveland Federal Reserve President Beth Hammack argued twice this week that the Fed should increase rates now. Odds of a December rate hike now sit near 73%.
How is the Canadian stock market performing?
The better story is at home. The S&P/TSX Index set records this week, going above 36,600, and is up more than 15% this year. Financial stocks and materials companies led, as gold prices increased.
Macro data improved as well. Canada added 75,000 jobs in July, with unemployment at 6.4% (a two-year low). Set that against where this year started: two quarters of economic contraction and job growth near a decade low. The economy that looked broken in June is now expanding, which changes the debate. The Bank of Canada is expected to hold its interest rate in September, and the argument is no longer between a hike and a cut but about how long interest rates can stay at a neutral level (neither stimulating nor restraining the economy).
There are two things worth watching. The loonie at close to 1.3944 has quietly flattered U.S. returns for Canadian investors this year, but this will reverse if the loonie strengthens. And the same highly priced oil that threatens the Fed supports a stock market weighted toward energy and materials. Canada's stock index likes the same rising oil prices that worry the Fed.
Will the Strait of Hormuz reopen?
Under all of it, the Middle East conflict has not moved. Iran says it will keep the Strait of Hormuz shut until its demands are met, a senior Iranian source reported no progress on the interim deal, and crude oil has swung between roughly $77 and $83 on headlines alone. That is the tension heading into fall. Every constructive move since June has been an oil trade in disguise. Stocks keep pricing a resolution that negotiators keep failing to reach, and the cooling in inflation that justified this week's rally came from energy that has since bounced back.
What market data is coming up?
U.S. retail sales data on Monday will test whether a weakening labour market has reached the consumer. U.S. housing starts data and Home Depot’s earnings report will follow. Then the Jackson Hole Economic Symposium (an annual gathering of central bankers in Wyoming) will take place later in the month. This will be Fed Chair Kevin Warsh's first, with a committee openly split and one region calling for immediate action. After a week when markets celebrated a shrinking labour force, the question surrounding inflation and potential rate hikes is an uncomfortable one.
Listen to the latest podcast from the IG Investment Strategy Team for further insights.
