Wentz Weekly Insights
Labor Market Remains Strong While Oil Rises on OPEC Production Cuts
The energy markets, more specifically oil, moved back to the headlines last week after the latest monthly Ministerial Meeting of the Organization of the Petroleum Exporting Countries (OPEC). The meeting ended with the group announcing a 2 million barrels per day cut to oil production quotas. The announcement comes at a time where the oil market is already undersupplied with low inventories and reverses a decision it made all year in increasing production in effort to help narrow the imbalance between supply and demand. The group said the decision was made due to the “uncertain outlook for the global economy” and and to protect the oil industry and their own economies from the risk of a global slowdown.
Despite this, the oil market will remain undersupplied as OPEC+ has been unable to meet previous production quotas all year due to lack of capacity. Data from Platts shows OPEC+ nations produced 42.8 million bbl/day in August, which was over 3 million bbl/day below its monthly target. With such a shortfall, a 2 million bbl/day production cut should not have that large of an effect as the headline suggest, with most analysts seeing a physical cut of closer to 500k bbl/day. After being at the lowest level of the year, oil moved 16.5% higher last week on the news. OPEC+ wants oil prices staying around $90/barrel, and it looks like that is what they are going to get.
The Biden Administration responded by calling the decision shortsighted and a disappointment. Back in March, the Administration announced the U.S. would release 1 million bbl/day each day from its Strategic Petroleum Reserve (SPR) and the OPEC+ cut comes at the same time these releases are set to expire. The Administration, in an attempt to keep gas prices low before the Midterm elections one month away, said it will look at ways to minimize OPEC’s impact.
Meanwhile, the markets were focused labor market data that was mixed but mostly positive and shows there is work left to do. On Tuesday the Bureau of Labor Statistics said there were 10.1 million job openings at the end of August, a drop of 1.1 million compared to July for one of the largest monthly drops on record. Regardless of the large drop, job openings are still historically high. Prior to the pandemic, job opening were trending around 7 million. In addition, there are still 1.7 openings per person unemployed, reflecting a still tight labor market with an under supply of workers. Markets, however, rallied on the news over the idea the new data supports a slowing labor market and that would mean the Fed wouldn’t be able to raise rates as high as feared.
Then came the employment report on Friday that showed another 263,000 jobs were added to the economy in September which were widespread among different industries. The September report also marked the month that the number of people employed, at 158.936 million, moved over the previous high that was reached right before the pandemic in February 2020. The only weak part of the labor report was the labor force shrinking by 57k, but this comes after it expanded nearly 800k people in August. The job gains and lower labor force resulted in the unemployment rate falling to 3.5% from 3.7%, tying the lowest readings since 1969.
Wages rose 0.3% as expected and were 5.0% higher than a year prior. That is good, but not when accounting for inflation. With inflation estimated to be 8.1% in September, real wages are actually declining 3.1%.
The recent data shouldn’t be anything to take the Fed off its path of aggressively raising interest rates. That was in fact the message that was given by several Fed officials that made public remarks last week. The most notable was from Fed Governor Chris Waller who pushed back against a “Fed pivot” some were beginning to speculate. He acknowledged this speculation in the markets but reiterated inflation is far from the FOMC’s goal and we have not seen any meaningful progress yet.
This has been a situation of risk management and the greater risk is still inflation expectations becoming unanchored which would lead to uncontrollable inflation. To avoid that worst case scenario, the Federal Reserve has been consistent in its message that it will keep raising rates to a level of around 4.50% to 5.00% and hold rates there for some time until there is evidence inflation has moved lower. Until this changes, markets will most likely remain under downside pressure.
That takes us to this week where the focus will be on several inflation readings. The consumer price index comes out Thursday morning where the headline is expected to show a 0.2% monthly increase and the year-over-year rate falling to 8.1% from 8.3%. However, the bigger concern is the “core” index which is expected to have risen to 6.5% from 6.3%.
Third quarter earnings season will kick off this week as well. Attention will be on bank earnings Friday and how much banks set aside in loan loss reserves – cash banks set aside to cover potentially bad loans. This could give us clues on the overall economy; a higher amount will lead to more concerns about a slowing economy and more troubled consumer. We expect the dollar to be a notable talking point as well, after the currency’s huge appreciation this year, and how it impacts earnings.
Week in Review:
For the first time in several weeks, stocks got off to a positive start to the week. The reason this time was news from UK’s Finance Minister that the government will not follow through on its plans to cut taxes from the 45% tax rate for high earners. This provided support for the British pound as well as fixed income and equity markets, despite capital concerns on Credit Suisse after its announced restructuring. In addition, economic data came in weaker than expected from manufacturing surveys that indicated conditions slowed again, leading to demand concerns but alleviating fears of higher inflation and higher rates that helped markets. The S&P 500 had its best day since July, finishing 2.59% higher.
Global news led the markets higher again on Tuesday. A lower than expected increase in rates (25 basis points versus the 50 expected) from the Reserve Bank of Australia led to Tuesday’s gains, after the central bank said it wants to see how prior rate increases have affected the inflation outlook. In addition, U.S. job openings fell to 10.1 million from 11.2 million, suggesting a slowing labor market leading to speculation the Fed will not raise rates as much as projected. However, this is just one months of data and does not make a trend. This led to another rally in stocks, and a drop in bond yields, with the S&P 500 closing 3.06% higher marking its best two-day performance (+5.7%) since April 2020 when stocks snapped back from the Covid lows.
Markets took a breather on Wednesday with comments of skepticism over the recent bounce as stocks have yet to see capitulation that coincides with a market bottom. The highlight of the day was OPEC+ cutting oil production by 2 million barrels per day, although the cartel has not been able to meet previous quotas, the impact will be less than 2 million bbl/day. Skepticism over the markets becoming too optimistic for a Fed pivot led to a volatile day – Stocks were down as much as 1.8%, before recovering and moving positive, but ultimately finishing down 0.20%.
Stocks were mixed in early trading Thursday with a lack of headlines in a relatively quiet day, with data in the morning showing a slight increase in jobless claims. Fedspeak on the day included more pushback on a Fed pivot. The S&P 500 fell 1.02% on the day. Most the headlines occurred after the close, including hawkish comments from Fed Governor Waller that the Fed is aware of the markets speculation of a Fed pivot, but warning that is something that is not very likely as inflation is far from the FOMC’s goal, and a large revenue miss from chipmaker AMD.
The main event for the week was the DOL’s employment report Friday morning that showed 263,000 jobs were added in the economy in September. The job gains were as expected, as was the rest of the report. The strong job gains led to the concern the Fed wont pivot soon as the markets were starting to speculate. As a results stocks fell while yields rose with the S&P 500 down 2.80%.
After a sharp decline in Treasury yields two weeks ago, yields were a little less volatile last week with the 10-year Treasury yields rising 8 basis points through the week to finish at 3.88% while the 2-year yield was stable, ending at 4.31%. Oil had a big week after OPEC+ agreed to cut production, leading to a 16.5% increase in crude oil for the week. Stocks snapped a three week losing streak and ended another volatile week as follows: Russell 2000 +2.25%, Dow +1.99%, S&P 500 +1.51%, NASDAQ +0.73%.
Recent Economic Data
- The PMI index for September was 52.0, remaining subdued after a 51.5 reading from August (a reading above 50 represents expanding conditions while under 50 represents contracting activity). New orders and output returned to growth (over 50) in the month, while employment was strong but still showing labor shortages that is still limiting firms’ ability to work through backlogs. Expectations fell over concerns on inflation and client purchasing power.
- The ISM manufacturing index was 50.9 for September, weaker than expected and falling from 52.8 in August. New orders at 47.1, declining for the fourth consecutive month, and employment at 48.7, both contracted while production improved slightly. The prices index fell again and stands at 51.7, down a point and closer to breakeven for the lowest level since June 2020. Employment contracted, falling 5.5 points to 48.7 though there were no comments on large layoffs. The report notes the manufacturing sector continues to expand, but now at the slowest pace since the beginning of the pandemic as demand continues to ease.
- ISM services (non-manufacturing) index was 56.7, better than expected and follows a 56.9 from August, showing a more resilient services sector, versus the manufacturing sectors which, according to recent surveys, has been weakening over the past several months. There was weakness in new orders which fell in the month, while employment moved higher, and the prices index moved lower for the third consecutive month around 70 after nine straight months above 80 (a very high reading). The reports show the manufacturing sector weakened to its lowest levels since the early days of the pandemic while the services sectors remains well in expansion territory, despite recent declines.
- The amount spent on construction in August fell 0.7% versus the expected 0.1% decline and comes after a 0.6% decline in July. Spending on residential construction fell 1.0% while spending on nonresidential fell 0.4%. Compared to a year ago construction spending is 8.5% higher, mostly due to a 12.4% increase from residential in addition to a 4.7% increase in nonresidential.
- New orders for manufactured goods, also known as factory orders, were unchanged in August, slightly lower than the 0.2% increase expected, but comes off a 1% decline in July. Shipments remain strong, rising 17 of the past 18 months, rising 0.4% in August following a 0.3% increase in July. The important component, which is a direct input to GDP – new orders for durable goods, fell 0.2% in the month for the second straight month.
- In September there were 13.5 million vehicles sold (at an annual rate), right in line with expectations and rising from the 13.1 million pace from August. Prior to the pandemic vehicle sales trended in the 17-18 million range but since then, because of the semiconductor shortages, sales have trended between 13 million and 15 million.
- Trade data from the Census Bureau shows the U.S. trade deficit was $67.4 billion in August, down $3.1 billion from July’s deficit of $70.5 billion. The decline was due to a 1.1% decline in imports, to $326.3 billion, offset by exports showing a smaller 0.3% decline, to $258.9 billion. With the trade deficit falling, trade will be a large contributor to Q3 GDP, reversing the large negative contribution it made over the first half of the year.
- On the last business day of August, there were 10.1 million job openings, a drop from 11.2 million in July, for the lowest since June 2021. Job openings are still relatively high – prior to the pandemic openings were trending around 7 million. However, there is still almost two job openings for every person unemployed. The number of hires was unchanged at 6.3 million, while separations increased slightly to 5.98 million from 5.79 million. Within separations, quits increased slightly to 4.158 million from 4.058 million, while layoffs increased as well, to 1.46 million from 1.39 million.
- ADP saw 208,000 new payrolls added in September, up from 185,000 in August, and was right near expectations. Recall, it was the last report (for the month of August) where ADP’s total payroll number exceeded the pre-pandemic high. Total payrolls now stand at 121.832 million.
- The number of unemployment claims filed the week ended October 1 was 219,000, an increase of 29k from the prior week, with the four-week average relatively unchanged at 206,500. The number of continuing claims was 1.361 million, up 15k from the week prior, with the four-week average down 1k to 1.346 million.
- The DOL reported nonfarm payrolls grew by 263,000 in September which was right in line with expectations. Job gains were seen most in leisure and hospitality, healthcare, and professional services, which added 83k, 60k, and 46k jobs, respectively. Manufacturing added 22k and construction added 19k jobs while the only sectors seeing job losses were transportation/warehousing, retail trade, and government. One of the only negatives was the labor force declined in the month, after a strong gain in August put it back above pre-pandemic levels. The 57k decline in the labor force resulted in the labor force participation rate moving to 62.3% from 62.4%. As a result of the job gains combined with the lower labor force, the unemployment rate fell to 3.5% from 3.7%. However, with the job gains, the U.S. now has 158.936 million people employed, for a new all-time high, rising above the previous high that was reached February 2020 right before the pandemic. Average hourly earnings rose 0.3%, in line with expectations and 5.0% higher than a year ago, slowing from the 5.2% rate in August. On a real basis, wages are still down 3.0% after factoring in inflation. Compared to pracademic, wages are now 13.8% higher while consumer prices (CPI) is 14.1% higher. This was a very much ‘as expected’ report to slightly better than expected. As a result stocks immediately moved lower with yields moving slightly higher. Market is wanting to see weaker data before being convinced the Fed is nearing the end of its rate hiking cycle.
- Poshmark, a social marketplace for new and secondhand products, announced it will be acquired by South Korean internet company Naver in effort to expand and diversify its e-commerce platform. It will be an all cash deal in which Poshmark shareholders will receive $17.90 per share, representing a value of $1.2 billion, or a 15% premium to Poshmark’s price prior to the announcement.
- Memory chip maker Micron said it would spend up to $100 billion on a massive new chipmaking facility outside of Syracuse, New York. The project will involve 20 years of investment and construction in the facility and was driven by the federal investment in the domestic semiconductor industry from the CHIPS Act.
- AMD is the latest semiconductor company to reduce guidance. It said last week its revenues would be around $5.6 billion for the third quarter, well below consensus estimates of $6.7 billion. The reason was a significant weakening in the PC market and a “significant inventory correction across the PC supply chain.” It added data center, embedded and gaming segments continued to show strong strength though (data center up 45% y/y, gaming up 14%, and embedded up 4%). It appears the miss on revenues was almost entirely due to the PC segment. This is expected to continue over the next two quarters until inventories correct enough, during which time these semi stocks typically bottom.
- ESPN (Disney) is nearing a deal with DraftKings on an exclusive partnership that would lead to a sportsbook and rebranding itself with the ESPN brand. Specifics are still unknown but speculation is the deal will include shows and odds that would be integrated into game broadcasts. ESPN owns a 4% stake in DraftKings.
- OPEC+ nations agreed to make a production cut of 2 million barrels per day, reversing decisions it made through 2022 to increase production, drawing immediate criticism from the White House. The Administration called it “shortsighted” and said it would consult with Congress on how to reduce OPEC’s control over energy prices, while Biden hinted at more releases from the U.S. Strategic Petroleum Reserve (SPR). OPEC said the move was due to the uncertain outlook and to protect the oil industry and their own economies from the risk of a global slowdown, with Nigeria’s Oil Minister saying OPEC wants prices around $90USD and it would destabilize some economies if it fell below that price. While it is highly unusual to cut production in an undersupplied market, recall that all year OPEC+ has been unable to meet its production targets as it is, so this will have a smaller effect than the 2 million bbl/day production cut that is in the headlines. Therefore, the new production cut will likely bring total production back in line with quotas. However, at the same time, the U.S. will be ending its release from the SPR which equated to 1 million bbl/day.
- The Reserve Bank of Australia rose its cash rate 25 basis points, but this was less than the 50 bps that was expected and the first time the central bank raised less than 50 bps since its meeting in spring. It said it still expects further rate increases over the period ahead. The reason for the smaller increase was due to the substantial increase over a short period of time and a desire from policymakers to see how those increases have so far affected the outlook for inflation and growth.
- With limited details, the European Union has agreed on new sanctions against Russia, including a price cap on Russian oil, which was anticipated. The sanctions also include limits on EU exports of aircraft components and limiting steels imports from Russia.
- With one month to go before the Midterm elections, the Biden Administration is asking the Department of Justice and Dept of Human and Health Services to review “expeditiously” how marijuana is scheduled under federal law, aiming to de-criminalize the drug. He also said he would be pardoning all people convicted of simple possession of marijuana.
- Recent Fed speak:
- Richmond Fed President said if we are in a new era which we face high inflationary headwinds, that could require periods of tightening policy more than what has been the recent pattern.
- Atlanta Fed President Bostic said policymakers need to “remain purposeful and resolute” in bringing inflation toward the Fed’s goal, saying we are only seven months into the tightening cycle and we have some ways to go. He expects the fed funds rate to get to 4%-4.5% by year end and holding at those levels to see how inflation and the economy respond, which could create short-term pain.
- New Fed Governor Lisa Cook said in her first public remarks as a Fed Governor that inflation has been stubbornly persistent and she sees value in front-loading rate increases. She also said policy judgment should be based on whether inflation is seen falling in the data, not just in the forecasts.
- Minneapolis Fed President Kashkari said the FOMC is “quite a ways away” from pausing its rate increases adding that the bar should be set high for a shift in the Fed’s stance. He does not see evidence yet that wages and services prices are moving down.
- Chicago Fed President Evans said unemployment should be expected to creep up, but core inflation is what still concerns the Fed, adding that inflation is not just confined to several sectors right now, but is widespread. Acknowledged the Fed started too late, and says balance sheet runoff should continue for about three years. Sees rates at 4.75% by spring.
- Fed Governor Waller gave some pretty hawkish remarks, saying inflation is far from the FOMC goal of 2% and not likely to fall quickly and in his view we haven’t yet made any meaningful progress on inflation. He said the FOMC will not pivot unless inflation comes down closer to its target. He said he is aware of the speculation in markets the concerns over financial stability/liquidity concerns could lead to the FOMC to adjust policy, but says “this is not something I’m considering or believe to be a very likely development,” while saying markets are operating effectively. He says if job growth continues to slow, this is not sufficient to significantly alter his view of the economy.
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The Week Ahead
Monday is a bank holiday (Columbus Day) and fixed income markets will be closed but the stock markets will remain open. After a week full of labor market data, the economic calendar turns to inflation data this week while the earnings calendar picks up with third quarter earnings season kicking off. Inflation reports this week include the producer price index on Wednesday, the consumer price index on Thursday, and import and export prices on Friday. The CPI is expected to show a 0.2% increase in the month of September, with a year-over-year increase of 8.1%, falling from 8.3%, while core prices are expected to have accelerated with a 6.5% y/y increase from 6.3% the prior month. Elsewhere, we will see jobless claims on Thursday, then retail sales and business inventories for Friday. The FOMC meeting minutes from the Fed’s September meeting is released on Wednesday morning where investors will focus on the conversation around how high Fed officials see rates going and for how long. It will also be another busy week of Fedspeak with several Fed officials making public appearances. Earnings will come back in the spotlight with results coming rom PepsiCo on Tuesday, Delta, Domino’s Pizza, Fastenal, Taiwan Semiconductor, and Walgreens on Thursday, and a round of bank earnings on Friday including JPMorgan, Citigroup, Morgan Stanley, Wells Fargo, and U.S. Bancorp.