Why Do Investors Worry About the Federal Reserve's Next Move?

Stock indexes start the week near record territory as the streak of positive economic and earnings data continues. The S&P 500 is now up more than +18% for the year with the Dow and Nasdaq both up +16%.

On Friday, data showed that job gains in July accelerated to +943,000, bringing the overall unemployment rated down to 5.4% from 5.9% the previous month. The “leisure and hospitality” sector by far led the hiring blitz, accounting for around +380,000 new jobs, followed by “government” with a gain of +240,000. Other positives included a jump in the labor force participation rate and an accelerating decline in the number of “underemployed” people, meaning those working part-time because they can’t find full-time work.

Economists note that these and other improvements indicate the labor market has likely avoided the type of long-term “scarring” that many economists say resulted from the Great Recession.

At the current rate of job growth, the labor market would be back to pre-pandemic levels by February 2022. Even if the pace were to slow to half the current rate, economists say the job market will be mostly recovered by the end of next year. For the sake of comparison, it took nearly a decade for the labor market to recover from the Great Recession. The all-around positive July report also marks another step toward the Fed’s goal of “substantial further progress” in the labor market and supports the popular view on Wall Street that the central bank will begin reducing asset purchases later this year.

Federal Reserve

Investors suspect the Fed will lay out details on when and by how much it will begin tapering its bond purchases at the annual Jackson Hole conference on August 26-28, or possibly its next policy meeting on September 21-22.

The timing for the Fed to start lifting its benchmark interest rate is a little less certain. Most are still looking at sometime in 2023 but a growing number of analysts believe a rate hike in 2022 could be in the cards if economic growth really takes off.

Most in the bear camp think the current level of inflation already justifies a rate hike, though bulls argue that higher prices mostly stem from lingering pandemic-induced supply chain dislocations that can’t be fixed by Federal Reserve policy. The Federal Reserve of course believes inflation is “transitory” and expects prices to come down as supply chain dislocations and labor shortages ease.

Data to watch

Investors this week are anxious to see the latest reads on inflation with the Consumer Price Index on Wednesday and the Producer Price Index on Thursday. While insiders expect both indexes rose further in July, they expect the pace slowed substantially from previous months, which would be a welcome indication that inflationary pressures may be easing.

Today’s key data is the Labor Department’s Job Openings and Labor Turnover Survey (JOLTS), which will provide some deeper insights into the state of the labor market.

Turning to earnings, things start to slow down this week with nearly 90% of S&P 500 companies having reported, with 87% of them topping earnings estimates. The big beats have now lifted the Q2 earnings growth rate to nearly +89%. Today’s highlights include AMC, Barrick Gold, BioNTech, Dish Network, Elanco, Nutrien, Planet Fitness, and Tyson Foods.

Delta variant

Investors also continue to monitor the headline risk associated with the Delta variant. The situation in Asia, in particular, is being nervously watched as new outbreaks of just a handful of people can result in lockdowns of entire cities in China, South Korea, Vietnam, and other major Asian manufacturers. I think some of the foreign governments have a very itchy trigger finger when it comes to shutting down as they try to avoid another major Covid outbreak. Some of the worst supply chain snags in the U.S. are still the result of port congestion stemming from equipment and labor shortages.

Experts are worried the problems are only going to compound as we head into the holiday shipping season, which is starting earlier this year as a lot of importers pulled forward their holiday deliveries in anticipation of continued delays. Bottom line, most shipping experts think it will be 2022 before supply chains are able to fully recover.

Technical analysis

SP500 broke above the resistance level. And, there is a lot of similarities with price action before the COVID sell-off. The price has also broken above very strong resistance and stuck in a tight range, while Insider Accumulation formed bearish divergence. So, there is a chance for interesting price action in August.

Overall the markets have not shown any weakness yet and may continue to push higher after consolidation. However, traders and investors should be somewhat concerned that any breakdown in price may prompt at least -13% to -18% pullback. The natural cycles are a bit mixed now, but they forecast a potential middle-term rally at the end of September or at the beginning of October.

Insider accumulation and natural cycles gave great insight before COVID happened. Let us see how it plays now.