Market snapshot: US rate fears continue to cause problems

Another set of stronger-than-expected employment data today will only make further interest rate rises more likely. Our head of markets assesses the implications. 

Stocks stumbled as the latest US economic readings showed no immediate signs of a slowdown, which in turn could redouble the Federal Reserve’s efforts to tame inflation come what may.

The ADP payrolls data showed an increase of 497,000 private sector jobs, significantly in excess of both the expected and previous month’s numbers of 220,000 and 267,000 respectively.

While the report is not seen as a particularly reliable guide, it nonetheless served to set the cat among the pigeons ahead of the key non-farm payrolls report today. The consensus for the non-farms has ticked higher over recent days, and now estimates that 240,000 jobs will have been added in June, as compared to 339,000 in May.

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However, the likelihood of a hotter number is hanging in the air, which has caused some consternation among investors, who are becoming increasingly resigned to a longer period of higher interest rates becoming entrenched. A further interest rate hike at the July meeting is all but nailed on according to estimates, which will then potentially lead to another rise in September.

The overarching concern is the difficulty of the Fed’s task in assessing when the brakes can be tapped on any more hikes when inflation is sufficiently under control. At that point, it remains to be seen whether there had been an overtightening of monetary policy, which in turn could plunge the world’s largest economy into recessionary territory.

The latest set of Fed minutes were further proof it were needed that the terminal interest rate remains some way off, and that the central bank will remain focused on reducing inflation, even recognising that the repercussions of these actions could be detrimental to the economy.

After this shortened trading week in the US (markets shut Tuesday for 4th July celebrations), attention will turn next week to another inflation release and the onset of the half-yearly corporate reporting season. This could prove to be more of an acid test for markets, since while the economy has held up well at the macro level, it is largely expected that some negative effects will have been felt by the companies on the ground, whether that be through wage inflation, pressure on costs generally and any resultant impact on margins.

In the meantime, the current levels of uncertainty surrounding markets have done little to alter what has been a strong performance from the main indices. In the year to date, the Dow Jones is up by 2.3% and the S&P500 by 15%, while the Nasdaq remains the star performer given the strength of a cluster of mega-cap technology stocks and has added 31%.

Asian markets also succumbed to concerns around global growth alongside continuing monetary tightening. In addition, Chinese banking stocks fell further, registering a loss of some 10% this week on the back of a softening outlook on the recovery story. Local government debt has emerged as another concern to add to an ailing property sector, non-committal consumer spending and high youth unemployment, let alone the apparently simmering tensions between the US and China.

After a poor showing on Thursday, the FTSE100 again failed to find favour among investors in early trade, as the index slipped further. A toxic combination of lower commodity and oil prices has weighed on the index, alongside the potential of lessening demand from China.

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The fragility of the global picture has also weighed on the likes of the banks, where it remains to be seen whether debt defaults are trending upwards, and indeed whether the banks will be adding to provisions when they report half-year numbers at the end of this month.

As such, any gains from earlier in the year have been erased, with higher bond yields and interest rate expectations also lessening the appeal of the FTSE100’s traditional attraction for income stocks. The current average dividend yield of 3.9% now looks tame in comparison to the returns being offered elsewhere, and the overall result is that the premier index has now fallen by 2.7% in the year to date.

The likelihood of further interest rate rises clamping down on an already anaemic growth story in the UK has had additional impact on the FTSE250, which has now dropped by 5.2% so far this year.