Stocks Retreat as U.S. Labor Strength Bolsters the Outlook for Higher Interest Rates

What you need to know…

The S&P 500 Index ($SPX) (SPY) Thursday closed down -0.79%, the Dow Jones Industrials Index ($DOWI) (DIA) closed down -1.07%, and the Nasdaq 100 Index ($IUXX) (QQQ) closed down -0.75%.

Stock indexes Thursday closed moderately lower, with the Dow Jones Industrials falling to a 1-week low.  Stocks and bonds retreated Thursday after stronger-than-expected U.S. economic reports on Jun ADP employment and Jun ISM services bolstered the outlook for the Fed to be more aggressive in raising interest rates.

Stock index futures extended their losses, and bond yields rose even further Thursday morning on a blowout Jun ADP employment report that showed employers added the most jobs in 16 months.  Also, the Jun ISM services index rose more than expected to a 4-month high.

The U.S. Jun ADP employment change surged by +497,000, well above expectations of +225,000 and the most in 16 months, signaling strength in the U.S. labor market.

U.S. weekly initial unemployment claims rose +12,000 to 248,000, slightly more than expectations of +245,000.  Weekly continuing claims fell -13,000 to a 4-month low of 1.720 million, showing a stronger labor market than expectations of 1.737 million.

The U.S. May trade deficit shrank to -$69.0 billion from -$74.4 billion in Apr, right on expectations.

U.S. May JOLTS job openings fell -496,000 to 9.824 million, showing a weaker labor market than expectations of 9.900 million.

The U.S. Jun ISM services index rose +3.6 to a 4-month high of 53.9, stronger than expectations of 51.2.

Hawkish Fed comments also weighed on stock and bond prices.  Late Wednesday, New York Fed President Williams said the incoming data the Fed has seen so far support the "hypothesis" that the Fed has more work to do on monetary policy.  On Thursday, Dallas Fed President Logan said, "I think more-restrictive monetary policy will be needed to achieve the FOMC's goals of stable prices and maximum employment."

The markets are discounting the odds at 89% for a +25 bp rate hike at the next FOMC meeting on July 25-26, up from 85% on Wednesday.  The markets are anticipating a peak funds rate of 5.42% by November, which is +34 bp higher than the current effective federal funds rate of 5.08%.

Global bond yields Thursday rose sharply.  The 10-year T-note yield jumped to a 4-month high of 4.081% and finished up +11.1 bp to 4.043%.  The 10-year German bund yield rose to a 3-3/4 month high of 2.641% and finished up +14.9 bp at 2.626%.  The 10-year UK Gilt yield soared to a 14-year high of 4.699% and finished up +16.6 bp at 4.660%. 

Overseas stock markets settled lower.  The Euro Stoxx 50 closed -2.93%.  China’s Shanghai Composite Index today closed -0.54%. Japan’s Nikkei Stock Index today closed -1.70%.

Today’s stock movers…

Homebuilders fell Thursday after the 10-year T-note yield jumped to a 4-month high, raising mortgage rates and dampening home-buying prospects.  As a result, DR Horton (DHI) and Lennar (LEN) closed down more than -3%.  Also, PulteGroup (PHM) closed down more than -2%, and Toll Brothers (TOL) closed down more than -1%.

MercadoLibre (MELI) closed down more than -7% to lead losers in the Nasdaq 100 after JPMorgan Chase said the risk of an Argentine peso devaluation could lead to a -7% hit to the stock’s EPS.

American Express (AXP) closed down more than -2% after Baird downgraded the stock to neutral from outperform.   

Exxon Mobil (XOM) closed down more than -3% after it said lower natural gas prices and refining margins would reduce Q2 earnings by about $4 billion compared with the previous quarter.

Bank stocks were under pressure Thursday and weighed on the overall market.  Citigroup (C) and Morgan Stanley (MS) closed down more than -3%.  Also, Bank of America (BAC) and Goldman Sachs (GS) closed down more than -2%.

BorgWarner (BWA) closed up more than +3% to lead gainers in the S&P 500 after Bank of America Global Research upgraded the stock to buy from neutral. 

Keurig Dr Pepper (KDP) closed up more than +1% to lead gainers in the Nasdaq 100 after Morgan Stanley upgraded the stock to overweight from equal weight, noting the stock’s “compelling” valuation.

Microsoft (MSFT) closed up +0.92% to lead gainers in the Dow Jones Industrials after Morgan Stanley raised its price target on the stock to $415 from $355 and said artificial intelligence-driven gains could propel the stock to a more than $3 trillion valuation. 

Rollins (ROL) closed up more than +1% after Bank of America Global Research initiated coverage of the stock with a buy recommendation and a price target of $49.

Aptiv Plc (APTV) closed up more than +1% after Bank of America Global Research upgraded the stock to buy from neutral. 

Across the markets…

September 10-year T-notes (ZNU23) Thursday closed down -24 ticks, and the 10-year T-note yield rose +11.1 bp to 4.043%.  Sep T-notes Thursday tumbled to a 4-month low, and the 10-year T-note yield jumped to a 4-month high of 4.081%.  Stronger than expected U.S. reports on Jun ADP employment and Jun ISM services weighed on T-notes as the strong reports bolstered the prospects for tighter Fed policy.  Also, hawkish comments from New York Fed President Williams and Dallas Fed President Logan undercut T-notes when they signaled that they favored more restrictive Fed policy.  T-notes recovered from their worst levels as a slide in stock spurred some safe-haven demand for T-notes.

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