August 5, 2024

As one pundit put it after Friday’s downside wipeout, the Fed has now snatched defeat from the hands of victory. I assume that this means that instead of beginning to lower interest rates this past week, they are now way behind the curve with yields in the bond market tumbling and now they cannot do this until the next meeting on September 18th which means that the federal funds rate cut is now six weeks away.

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And a disaster it was with the Dow falling by 610 points to 39,757 led by huge declines in AXP, CAT, GS and AMZN and INTC on poor earnings and for the latter it was the worst one-day showing since 1974. Even advances by UNH, MCD and PG could not stem the downside pressure.

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The S&P collapsed by 100 points to 5346 led by all the large technology (AAPL put in a small earnings-related gain) in addition to financials, industrials and so on. It was the worst two-day decline since March 2023 and the worst single-day wipeout since June 4th.

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The Nasdaq collapsed by 418 points to 16,776 and is now in an official 10% downside correction after being the glamorous upside leader for the first half of the year.

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And how about the recently beloved Russell 2000 Index of small stocks, which got smoked by 77 points down to 2109 for its worst two-day decline since June 2022.

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And the VIX really went nuts on the upside and got as high as 29.66 before settling back to end at 23.39, which was the highest since March 2023.

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Stocks tumbled Friday on worries that the U.S. economy could be cracking under the weight of high interest rates meant to whip inflation. The July non-farm payrolls report was a disaster in the sense that it showed hiring by U.S. employers slowed last month by much more than economists expected sent fear through markets, with both stocks and bond yields dropping sharply. It showed the creation of just 114,000 jobs with the unemployment rate at 4.3% which was the highest since October 2021. It followed a batch of weaker-than-expected reports on the economy from a day earlier, including a worsening for U.S. manufacturing activity, which has been one of the areas hurt most by high rates.

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And it was just two days before that stock indexes jumped to their best day in months after Federal Reserve Chair Jerome Powell gave the clearest indication yet that inflation has slowed enough for cuts to rates to begin in September.

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Now, worries are rising the Fed may have kept its main interest rate at a two-decade high for too long. A rate cut would make it easier for U.S. households and companies to borrow money and boost the economy, but it could take months to a year for the full effects to filter through.

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The problem is that economic momentum has slowed so much that a rate cut in September will be too little and too late. They will now have to do something bigger than the traditional cut of a quarter of a percentage point to avert a recession such as an intraday meeting cut but as I said before, to wait six weeks is really too much for the market to deal with.

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Traders are now betting on a 70% probability that the Fed will cut its main interest rate by half a percentage point in September, according to data from CME Group. That’s even though Powell said Wednesday that such a deep reduction is “not something we’re thinking about right now.”

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Of course, the U.S. economy is still growing, and a recession is far from a certainty. The Fed has been clear about the tightrope it is walking since it started hiking rates sharply in March 2022: Being too aggressive would choke the economy but going too soft would give inflation more oxygen. While refusing to claim victory on either the jobs or the inflation fronts on Wednesday, before the discouraging economic reports hit, Powell said Fed officials “have a lot of room to respond if we were to see weakness” in the job market after hiking its main rate so high.

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U.S. stocks had already appeared to be headed for losses Friday before the disappointing jobs report thudded into view at 8:30am.

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AMZN fell by 9% after reporting weaker revenue for the latest quarter than expected. The retail and tech giant also gave a forecast for operating profit for the summer that fell short of analysts’ expectations.

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INTC dropped even more, 26%, for its worst day in 50 years, after the chip company’s profit for the latest quarter fell well short of forecasts. It also suspended its dividend payment and forecast a loss for the third quarter, when analysts were expecting a profit.

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Helpfully, other areas of the stock market beaten down by high interest rates began rebounding sharply last month when tech stocks were regressing, particularly smaller companies. But they tumbled too Friday on worries that a fragile economy could undercut their profits.

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In the bond market, Treasury yields fell sharply as traders forecasted deeper cuts to rates coming from the Federal Reserve. The yield on the 10-year Treasury fell to 3.79% from 3.98% late Thursday and from 4.70% in April.

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In stock markets abroad, Japan’s Nikkei 225 dropped 5.8%. It’s been struggling since the Bank of Japan raised its benchmark interest rate on Wednesday. The hike pushed up the value of the Japanese yen against the U.S. dollar exporters and deflate a boom in tourism. Chinese stocks fell as investors registered disappointment with the government’s latest efforts to spur growth through various piecemeal measures, instead of hoped-for infusions of broader stimulus, while stock indexes dropped by more than 1% across much of Europe.

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Commodity prices also had a rough ride last week. Oil prices leaped after the killings of leaders of Hamas and Hezbollah fueled fears that a widening conflict in the Middle East could disrupt the flow of crude.

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But prices fell back Thursday and Friday on worries that a weakening economy would burn less fuel. A barrel of benchmark U.S. crude dropped back below $74 Friday after coming into the week above $77.

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Earnings this week will see (one day at a time): today – CAR, BCC, CSX, PGR.

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Economic reports will see: today – July ISM Services report came in a little better than expected at 51.4; Thursday – weekly jobless claims.