Scott Olson/Getty ImagesFinancial markets are finally coming around to the idea that U.S. interest rates are likely staying higher for longer, driven by Thursday’s blowout private-sector jobs report for June from ADP and the prospect of another strong official labor-market reading on Friday.It’s taken a while to get to this point, but the data finally appears to be too much to ignore. After payroll-services firm ADP reported 497,000 private-sector jobs were added in June — more than twice as many as forecasters had expected — the policy-sensitive 2-year rate BX:TMUBMUSD02Y briefly touched its highest level in 17 years and ended at 5%, while the benchmark 10-year yield BX:TMUBMUSD10Y finished above the 4% level commonly associated with a healthy U.S. economy. All three major stock indexes SPXCOMP closed lower, with Dow industrials DJIA diving 366.38 points or almost 1.1%.While Thursday’s “ferocious” pullback in stocks could repeat itself in the months ahead, investors are likely now in an environment in which the lows reached in Dow industrials and the S&P 500 last October can hold up, according to Brian Jacobsen, chief economist for Annex Wealth Management in Elm Grove, Wisconsin, which manages $4.2 billion in assets. That’s because headline inflation has eased from a 9.1% peak last June, even as core readings remain stubbornly persistent. Jacobsen likens the current environment to the 2012-2015 period marked by a “taper tantrum” in U.S. yields and the Federal Reserve’s need to take away the proverbial punch bowl, as well as by a resilient economy that produced a jobless recovery.“The market moves over the last few days— especially in reaction to the whole mosaic of data as far as strong jobs gains, reduced quit rates, manufacturing weakness, and service-sector strength — have woken people up to the idea that the Fed’s job is not done,” Jacobsen said via phone on Thursday. “We expect dips, but not corrections or the start of a bear market,” Jacobsen said of U.S. equities. “We see a choppy path with plenty of opportunities to buy,” adding that he thinks investors should start to position for a recovery in corporate earnings. For much of this year, investors and traders have been preparing for the central bank to end its most aggressive campaign of rate hikes in four decades, and to start cutting borrowing costs much sooner than policy makers have signaled. The trouble is that inflation isn’t falling by nearly as much as it should when looking at just the core readings which policy makers care about the most, whether they’re derived from the consumer-price index or the Fed’s preferred personal-consumption expenditures index.Read: Wall Street investors grapple with how ‘last mile’ of U.S. inflation will play outThe U.S. labor market’s continued upside surprises suggest more problems ahead for the Fed’s inflation-fighting campaign, and are shaking up more than just stocks and bonds. Gold futures settled at their lowest since March after Thursday’s private-sector data and oil came under pressure before eking out a gain. Meanwhile, the CBOE Volatility Index VIX, a popular measure of the stock market’s expectations for volatility, popped on Thursday. Friday’s nonfarm payroll report from the U.S. Labor Department is expected to show a gain of 240,000 jobs for June, accompanied by a 3.6% unemployment rate, the median estimates of economists polled by The Wall Street Journal. Analysts said that a strong ADP private-sector report can still act as a bellwether for the official figures that follow, though ADP itself has said that it does not try to forecast the government’s monthly job report.Edward Moya, senior market analyst for the Americas at OANDA Corp. in New York, said he sees the possibility of a greater-than-expected 300,000-plus job gains being reported on Friday that could rattle investors even further.“The market was complacent and expected that we were going to get just one more rate hike,” Moya said via phone. However, “a 2-year rate above 5% shows you that the market is starting to respect the ‘higher-for-longer’ theme on rates, and that too much strength in this economy will force the Fed to deliver more rate hikes.”“The stock market has surprised this year mainly because of seven stocks and market breadth is going to struggle from here,” Moya said on Thursday. “If the Fed continues to raise rates, it’s going to get ugly pretty quickly. For the real economy to thrive, we really need inflation to be conquered and we are probably going to see some rough waters from here.”The Fed’s efforts to tighten financial conditions and the economy may even be working against the central bank to some extent. Higher interest rates are producing an extra source of income for savers, and that group is benefiting first before the lagged, negative impact on borrowers can kick in, economists said. With the Covid-19 pandemic helping many people stuff more money into savings, a swath of Americans are now in the position of being able to use their interest income to pay down credit cards, spend, invest, or boost their cash piles.Judith Raneri, a portfolio manager at Gabelli Funds in Rye, New York, who runs the $3.6 billion Gabelli U.S. Treasury Money Market Fund, said that higher interest rates are helping many investors “make quite a significant amount of money” which can be used to pay off debt or left untouched to make even more interest on an ever-growing cash pile. Interest income is “becoming a significant part of investors’ bottom line and that nice chunk of change is working its way out across the entire economy,” at a time when the Fed is trying to slow the economy, she said via phone. “The main focus for the Fed is getting inflation down to its 2% target and it’s not focusing on anything beyond that. I’m in the camp that thinks the Fed will go 25 basis points in July and 25 basis points in September,” Raneri said via phone. Thursday’s ADP report “underscores how the labor market continues to show undeniable strength and is causing the Fed to continue with its mantra” of higher rates until the labor market softens to a point that impacts the economy.
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