If: Contradictory Data; Then: Pick Which Fits the Preferred Narrative

Today is the first Friday of the month, and thus traders were poised for the usual monthly jobs report.  With all eyes on one of the most consequential economic reports on the calendar, markets chose instead to focus on a piece of the less-anticipated ISM data.  But the latter data better fit the preferred narrative.

The slew of data from the Bureau of Labor Statistics – including Nonfarm Payrolls, Unemployment Rate, and Monthly Hourly Wages – is considered the most important means of assessing the health of the nation’s labor force.  Bearing in mind that half of the Federal Reserve’s dual mandate is full employment (along with stable prices), and that today’s report would be the final reading on these statistics ahead of the January 31^st FOMC meeting, there seemed be much riding on this morning’s data. 

The 8:30 EDT results bore some important contradictions, but the tone seemed to indicate a reasonably, if uneven, healthy labor picture.  The headline payrolls number for December increased to 216,000, well ahead of the expected 175k and last month’s reported 199k.  But there was a two-month net revision of -71k.  November’s 199k was revised to 173k, meaning that October’s number was reduced by another 45k.  Those more than offset the apparent 17k rise shown in the initial headline.  The unemployment rate remained at 3.7%, below the 3.8% consensus estimate.  But that was offset by a drop in labor force participation from 62.8% to 62.5%.  (Remember, the denominator in the unemployment rate calculation is the labor force.)

Yet the monthly rise in average hourly earnings was an unequivocally unfriendly piece of data for those hoping for imminent rate cuts.  That was expected to fall to 0.3%, but instead was unchanged at 0.4%.  That caused the yearly change to rise to 4.1%, above the 3.9% consensus estimate.  That sort of wage growth is good for earners, but not for those who are hoping for rate cuts as early as March.  Shortly after the numbers hit, I made this comment to a reporter:

Today’s numbers are a reality check for those who were banking on six rate cuts this year starting in March and stock and bond markets that had a ferocious year-end rally based on those themes.  We can quibble about the 2-month revisions and the labor force participation rate, but a beat in monthly hourly earnings is undoubtedly unfriendly to the aggressive rate cut narrative.

The immediate aftermath of the report showed a drop in equity index futures and a rise in bond yields as expectations for a cut in March fell from about 70% to just above 50-50.  But then stock futures pared their pre-market losses and yields improved somewhat.  There likely was too much risk aversion heading into the number, especially after published reports of a bearish trade in bond options that would pay off if yields rose to 4.15% today.  Also, the contradictions in the employment report allowed the prevailing narrative to shift back to being broadly consistent with the soft-landing narrative.  Equities opened with a modest rise, though yields remained slightly higher. 

Things were heading along on an uneventful path until 10:00 EDT.  Then, the ISM Services report came out.  It’s unfair to say that no one was anticipating the report, but it is fair to say that no one was expecting it to prove the more consequential set of data this morning.  The report was broadly weaker.  The headline services index was 50.6, well below the 52.5 expectation and last month’s 52.7, and new orders sank to 52.8, also well below the 56.1 expectation and last month’s 55.5.  Bearing in mind that these indices are constructed to show growth above 50 and shrinkage below, these modest positives are consistent with a soft landing.  As with the hourly earnings, the prices paid component was modestly above expectations, coming in at 57.4 vs a 57.3 consensus.  But that was below last month’s 58.3, so there too the growth slowed.

But the true shocker was the ISM Services Employment reading.  That came out at a stunning 43.3, way, way below the 51.0 expectation and last month’s 50.7.  Instead of modestly improving growth we see a significant decline.  Traders’ opinions changed dramatically.  Yields on 10-year notes flipped back below 4% and the S&P 500 jumped by a quick 25 points.  Most importantly, rate cut assumptions for March flipped quite substantially. 

Remember how we said that expectations for a March cut sank from about 70% to about 50%.  Well, now they are about 75%.  This is the case even after much of the effects of the 10AM moves have faded.  For better or worse, we’ll now need to pay even closer attention than usual to next week’s CPI and PPI reports for clues to the FOMC’s next move. 

But for this morning, for at least a few hours, the market picked the narrative that suited its preferred narrative.  We have been discussing traders’ selective listening and contradictory economic expectations for some time.  This morning we got all three.