Why Good Economic Numbers Can Cause a Selloff

2/4/2022

Markets

0 min read



  Image: Magda Ehlers (Pexels)

The Reason Investors are Hoping for Bad Economic Statistics

During 2021 the market went up on most economic numbers that indicated unexpected strength. One headline from mid-year reads, “Market Rally Amid Global Recovery Hopes; U.S. Payrolls Jump.” Flash forward to 2022, and the stock market is now spooked by a positive print. In a complete U-turn, a payroll number that surprises on the high side shakes the equity markets and brings out sellers. Why is good news now bad news, and which economic releases may cause the strongest market reaction?

Background

During 2021, the Fed was assuring the markets that interest rates would remain low for an extended period – a period measured in years. This did two things. First, it showed investors that the stimulative impact of low borrowing costs would keep consumer and business borrowing costs down. Second, it told investors they would earn very little if they invested in the fixed income markets. Ten-year Treasury notes last summer (August 5) traded as low as 1.19% per year, locked in for a decade. On the same date, the Russell 2000 returned 1.34% for the day. Investors that might typically invest all or some of their money in bonds found more risk in locking money up for ten years at just over a 1% annual return. Ten-year US treasuries now are priced to yield 1.8% or 50% more. Each increase in yield attracts more buyers to bonds, including higher-yielding corporate bonds and tax-exempt municipal offerings, pulling money away from other investments.

The Fed has now indicated that it is much more inclined to focus on inflation and avoiding an overheated economy. This translates to pushing up rates quicker if economic growth is strong. Pushing rates up, as mentioned earlier, increases borrowing costs for businesses and consumers while providing more attractive alternative investments that have an added benefit of a contractual obligation to pay a rate of interest.

Releases that Move Markets

Not all economic numbers have the same potential. There are economic numbers that can sway the market more than others. Equity investors that haven’t been paying much attention to economic releases in the past ought to at least mark their calendars with these three impactful reports, and monitor expectations.

Gross Domestic Product or GDP, is a quarterly report. The number is first estimated and released toward the end of the month following a calendar quarter-end. It’s reported by the Bureau
of Economic Analysis (BEA). This estimate is typically the most impactful for GDP. It is then fine-tuned for a second estimate late the next month and then finalized a month later. The subsequent reports can impact markets if they differ substantially from the previous estimate. Historically, the original estimate is fairly close to the final.

Gross Domestic Product, as its name implies is the total output of all goods and services produced within the U.S., this includes foreign companies operating within U.S. borders, and excludes domestic companies producing outside U.S. borders. It measures all economic activity and as such, can be the single most important economic indicator concerning interest rate changes.

A larger than anticipated increase quarter-to-quarter, or even an increasing trend can be viewed as inflationary; this promotes concern from the Federal Reserve. As a result, the Fed may feel the need to step in and raise interest rates in an effort to slow or temper the overall growth. On the other hand, a decline or a downward trend may cause the Federal Reserve to lower interest rates to spur growth.

Consumer Price Index or CPI, measures the average amount of change in prices paid over a period by consumers for a fixed cart of typical consumer goods and services. In other words, inflation. It’s released monthly by the Bureau
of Labor Statistics (BLS).

Inflation erodes the purchasing power of savings. As a result, investors typically have, as a minimum return benchmark to match or beat inflation. Interest rates naturally move up with inflation as investors demand to be better compensated (market reasons), and because the Fed may enact monetary policy to lower inflationary pressures that would include pushing up the cost of money to banks. Downward trending CPI reports allow the Fed room to lower rates and increase economic activity.

The Employment Situation Report or payroll employment is released each month by the BLS. The highlights of this economic release include: Total number of employed and unemployed, the unemployment rate, the number of people working full or part-time in both U.S. businesses and the government, the average number of hours worked per week by nonfarm workers, and the average hourly and weekly earnings for all nonfarm employees. From these statistics, investors and the Fed can discern the health of the employment situation. If payroll is trending up, or average hourly earnings are increasing at a high pace, this could be seen as foretelling inflation down the road. Inflation then leads to higher borrowing costs and more expected return from investments in interest-bearing securities like bonds.

Take-Away

When inflation is low the markets have much less to worry about and can be expected to rally on positive economic news, especially reports that are surprisingly positive. When inflation is running at a rate that may cause the Fed to intervene on positive economic news, then good news can be treated as bad by the equity markets.

The current state of the U.S. economy is that payroll employment is high, GDP is expected to break records, and inflation is near a level not seen in 40 years. With this in mind, the Fed will try to maintain a balance of stable growth and stable prices. If the economy is growing too quickly, there will be selloffs in anticipation of the Fed acting sooner rather than later.

Paul Hoffman

Managing Editor, Channelchek

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