ETFs Dip Following Strong Jobs Report

Investors expecting third straight 75 bp hike following stronger-than-expected July report on the labor market.

Stock and bond exchange-traded funds retreated Friday following an extremely strong U.S. jobs report.  

The SPDR S&P 500 ETF Trust (SPY) was trading lower by 0.3% midday after falling as much as 1.1% at its lows, while the iShares Core U.S. Aggregate Bond ETF (AGG) was trading down by 1%, just a hair off the low point of -1.3%. 

The economic narrative continued to shift on the heels of the Bureau of Labor Statistics report showing U.S. employers added 528,000 workers to their payrolls in July, more than double the 250,000 that economists surveyed by Bloomberg projected. 

The unemployment rate edged down from 3.6% to 3.5%, matching the prepandemic low from February 2020, the lowest unemployment rate since 1969.  

Wage growth also continued at a strong pace, rising 0.5% from June to July and 5.2% year over year. 

Resilient Economy  

With Friday’s jobs report, investors are no longer wondering whether the economy is in a recession. Two straight quarters of declining GDP or not, these jobs numbers, combined with strong data on factory orders and services from earlier this week, paint a picture of a resilient economy—not a contracting one. 

Inflation concerns are back to being front and center, however, given the strong growth in wages. Investors had hoped that a recent decline in key commodity prices, like those for gasoline and wheat, might help reduce inflation pressures. 

But while those are certainly helpful, they might not be enough to cool inflation in the face of such a robust jobs market. While the jobs data made the economic outlook clearer in one respect—we probably aren’t a recession today—it made it hazier regarding inflation.  

Moreover, even though a recession probably isn’t something the economy is experiencing today, it’s still a distinct possibility in the coming months, at least according to one key bond market indicator. 

Rate Hike Expectations Rising  

Investors ratcheted up their expectations of Fed rate hikes following the strong jobs data. Fed fund futures markets are now implying there is likely to be a third straight 75 basis point hike when the central bank makes it next policy decision in September. Beyond that, the markets see rates reaching as high as 3.75% by December.  

If those rate hikes come to fruition, the inversion in the Treasury yield curve could get even deeper. Today bond prices tanked and yields shot up, but the shorter end of the curve rose much more than the longer end.  

The two-year Treasury yield jumped by 20 basis points to 3.24%, while the 10-year Treasury yield increased by 15 basis points to 2.83%. That equals an inversion of 41 basis points for that part of the yield curve, which many are interpreting as a recession signal.  

For now, the stock market seems to be taking the bond market’s economic warnings in stride. Even after today’s modest pullback, SPY is up nearly 13% from its mid-June lows. The fund is now only down by 13.5% from its January highs, compared with a 23.4% loss at its lows. 

That suggests stock investors currently don’t expect anything more than a minor slowdown in the U.S. economy.  

Investors may get a better sense of whether or not they are being too optimistic after the release on Wednesday of the July consumer price index data, a commonly recognized benchmark that measures inflation in the U.S.  

Follow Sumit Roy on Twitter @sumitroy2