Morning Coffee: Stocks Week Ends on Down Note

Wall Street opened sharply higher after the August payrolls rose by 315,000, but a rise in the unemployment rate to 3.7% eased concerns about the Federal Reserve being too aggressive in raising interest rates as it attempts to bring down inflation. Early gains in the market were erased after Gazprom, the Russian state-controlled firm, with a monopoly on gas exports to Europe via pipeline, which were due to restart Saturday, said they could not safely restart deliveries until it fixed an oil leak found in a vital turbine and did not give a new time frame. The Dow Jones Industrial Average lost 337.98 points on Friday, or 1.07% to 31,318.44, the S&P 500 lost 42.59 points or 1.07% to 3,924.26 and the Nasdaq Composite lost 154.26 points or 1.31% to 11,630.86.

Employers added jobs at a decent pace in August. Payrolls increased by 315,000 in August, slightly above expectations. However, the jump in the unemployment rate to 3.7% was unexpected. The increase in the unemployment rate was driven by an increase in the labor participation rate, which rose to 62.4%, the highest reading in the last two years. The rise in the labor participation rate was driven by an expansion of the civilian labor force, which increased by more than three-quarters of a million people. The increase in the unemployment rate was for what economists say is “good reasons”, that is, more people are entering the labor force. The overall employment report reflects the beginning of what will be a slower labor market, heading back towards the trend, overall economic demand is slowing, and businesses are not so desperate for workers as in past months. Wage gains decelerated to a 0.3% gain for August, down from 0.5% in July, a sign of weaker inflation that will please the Fed. We look for further moves in the labor market towards a slower pace, moves that may also help cool inflation.

The ISM manufacturing index was unchanged at 52.8%. The new orders Index increased by 3.3 percentage points to 51.3 in August, up from 48% in July. August marked the first increase in orders after two months of declines. Lead times remain elevated. However, August saw a decrease in capital expenditures, raw materials and maintenance, repair and operating supplies, factors that will start to slowly build in coming months. Production fell by 3.1 percentage points to 50.4, with six industries reporting greater production. Materials availability and the labor supply continue to recover, with quits easing and supplier deliveries improving, conditions that could bring modest production increases in September. The ISM report shows that manufacturing activity is expanding at about the same rate as in the last two months. Supplier deliveries are about at the right tension mode and pricing is softening again, suggesting the supply-demand ratio continues to move towards balance. Companies continued to hire at a healthy rate in August, with few layoffs. The retreat in pricing is bringing buyers back into the market. There are concerns about the softening economy and order book corrections, but the slower pace is causing manufacturers to catch up on demand and reduce inflationary pressures. We look for a modest expansion of the industrial sector.

To find the area of greatest economic damage from the Fed’s rate hikes, you only need to look at the housing market. The Cass-Shiller Home Price Index rose 0.3% in June, a big step down from the 1.7% average monthly rise during the first five months of the year. Even with the slower June increase, the year-over-year increase was still 18%. Last year, home prices were driven by strong demand and limited inventory. The increase in prices this round is well above the peak of the last cycle. With the increase in mortgage rates, house prices are high enough that a large part of the American consumer populace cannot afford a house. Now prices are starting to cool and we will see a discounting increase in what is being transformed from a seller to a buyers market. The increase in mortgage rates is not helping construction spending. Construction spending fell 0.4% in July. Total nonresidential construction spending increased 0.9% but was offset by a 1.5% reduction in residential outlays. The public sector saw a strong 1.5% increase in construction spending. Total construction spending was up 8.5% above year-earlier levels.

This Week’s Economic Schedule: This week will be light on economic data, with only the trade balance and the ISM services index released.