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Today’s Points:

• Employment numbers gave markets their worst reversal since Liberation Day.
• Trump then fired the head of the Bureau of Labor Statistics. 
• The next Fed chair could be on the board within weeks after Kugler stepped down.
• Second-quarter earnings have barely done enough to keep the party going.
• AND: Some sporting singalongs.

Thud

It’s amazing how quickly momentum can reverse. The rally for risk assets had grown to look unstoppable since the US administration announced its first climbdown from the Liberation Day tariffs back in April. Nothing — not even a US attack on Iran or the reimposition of tariffs barely altered from the original plan — could stop stocks’ relentless outperformance. But for the second summer in a row, August has started with a dramatic reversal for stocks (proxied in the chart by the SPY exchange-traded fund) compared to bonds (proxied by the TLT ETF):

Last year’s briefly terrifying reversal centered on Tokyo, and on a disappointing unemployment report. There was alarm at the triggering of the so-called Sahm Rule, named for Bloomberg Opinion colleague Claudia Sahm, which predicts a recession from how fast the unemployment rate has risen from its recent low. This time around,  the Sahm Rule suggests a recession isn’t inevitable. Last year was a false alarm:

This year’s August surprise started with disappointing jobs numbers, compounded by desultory supply manager surveys, and then by the news that the president was firing Erika McEntarfer, the head of the Bureau of Labor Statistics. News that the Fed Governor Adriana Kugler was resigning broke shortly before markets closed in New York — and this is significant, as it opens the chance to put the candidate Trump chooses as the next Fed chair on the board within weeks. That would weaken the incumbent, Jerome Powell, while also sowing confusion. This is how the news affected the dollar: 

Was this reaction justified? Probably. For months, the US labor market has seemed strangely resilient. Payrolls are still growing, but this latest report incorporated massive downward revisions to show the weakest jobs growth since 2011:

That isn’t good for a multitude of reasons. It does, however, provide a clear justification to cut rates, as the president has been demanding. The problem is that inflation is picking up. The numbers are ambiguous but concerning. The Personal Consumption Expenditure deflator version of inflation, favored by the Fed, was released Thursday. Measuring it with the the Dallas Fed’s trimmed mean, favored by statisticians as a guide to underlying inflationary pressure, the direction is upward. Inflation never did return to the Fed’s 2% target:

This probably isn’t enough to stop a rate cut in September, but it’s cause for concern. The ISM manufacturing report, which was poor, did at least provide the relative cheer that the prices paid by manufacturers dipped sharply compared to expectation. It remains elevated, but this does suggest that the slowing economy is counteracting inflationary pressure:

All of this added up to the biggest one-day fall in the rate-sensitive two-year yield since the now little-remembered Powell Pivot at the December 2023 meeting of the Federal Open Market Committee — which appeared to promise imminent interest rate cuts, but didn’t. Earlier in the week, he had declined to make another such pivot, despite a couple of dissents from his colleagues. But with a data-dependent Fed, it is now a change in the numbers, rather than in the Fed’s words, that makes the difference:

The shift in expectations for the Fed’s trajectory was clear-cut. After the employment numbers, the Bloomberg World Interest Rate Probabilities function shows that implicit expected fed funds rates were cut sharply. Futures see the rate below 3% by the end of next year:

Last year’s August swoon was followed by a jumbo cut from the Fed, and soon swamped by excitement over an approaching Trump victory. Earnings resilience also helped. There’s a pretty good chance that happens again.

There are two new risk factors this time. First, inflation is rising. Friday was also the day that the government, far from chickening out, unveiled steep new tariffs on the rest of the world. Markets are not priced for these things. Second, US credibility is now at issue. This is driven by the erratic way the government has dealt with tariffs and with its attempt to unseat Powell. The BLS news added another front.  

Shooting the Messenger

Killing the messenger has a long and ignoble history. It shows up in Herodotus, when the Spartans did in a Persian envoy, and the concept of punishing bearers of bad news has recurred throughout history. Through all the centuries, it’s always been regarded as a bad idea. So, how to explain the presidential decision to fire the head of the Bureau of Labor Statistics after a very disappointing employment report?

The Trump decision is available on Truth Social. The key words are: 

I was just informed that our Country’s “Jobs Numbers” are being produced by a Biden Appointee, Dr. Erika McEntarfer, the Commissioner of Labor Statistics, who faked the Jobs Numbers before the Election to try and boost Kamala’s chances of Victory... I have directed my Team to fire this Biden Political Appointee, IMMEDIATELY. She will be replaced with someone much more competent and qualified. Important numbers like this must be fair and accurate, they can’t be manipulated for political purposes.

Notes that he admits that he had only just learned who McEntarfer was, and had immediately decided to fire her. Is there any basis for this? Well, it’s true that this was a big, negative revision — the biggest since the pandemic. The labor market is weaker than the previously published numbers had suggested, and that’s a problem:

But is this McEntarfer’s fault? Probably not. First, we can blame Covid-19. Companies got out of the habit of responding to government surveys in 2020 when the pandemic gave them more important things to do, and it’s proved habit-forming. Response rates are historically poor, so it’s not surprising that the numbers need revisions:

Secondly, we might blame the president’s former friend Elon Musk. The BLS was one of many agencies to suffer layoffs as the Department of Government Efficiency swept through the federal bureaucracy earlier this year. The agency was already complaining that it was needing to close its surveys altogether in some cities.

More importantly, the non-farm payroll report has always been prone to big revisions, provoking complaints. Counting all the people in work from the Florida Keys to Hawaii is after all pretty difficult. Noisy jobs data is a fact of life that market analysts and politicians alike need to tolerate. For proof, this is a column I wrote for my old employers in November 2006. I quoted the analyst Tim Bond, then of Barclays Capital, ahead of the non-farm payrolls release:

Rather like roulette, the payrolls number is more or less random, but within a reasonably well-defined range. The economics profession sets the range for the roulette wheel and the random-number generation techniques of the Bureau of Labor Statistics do the rest.

Bond suggested that it would make just as much sense to use grandmothers playing bingo to set bond prices. The BLS is aware of this and has been looking for remedies — which, as Justin Fox points out, have only added fodder for conspiracy theorists. 

The problem is credibility. Nobody taking over the job in these circumstances will be viewed as independent. This move further endangers the US role at the center of the world economy. 

Shooting the messenger remains a bad idea for all the reasons it has always been. For now, McEntarfer’s firing exists only in social media. The president has advisers who know that this is a terrible decision; there is still time for them to change his course. It wouldn’t be chickening out, just wise policy.

Earnings Heartbeat

The report card for second-quarter earnings season so far isn’t stellar. In aggregate, nearly all the measures of robust earnings are present: Growth is strong, and so is the magnitude of the number of companies topping analysts’ expectations. But such solid performances don’t prove that the outlook is positive, and weren’t enough to keep the stock rally going in the face of worrying macro news.

The median stock posting a positive earnings surprise has only outperformed the S&P 500 by 55 basis points on the day following the report, below the historical median “reward” of 101 basis points. Goldman Sachs’ David Kostin argues that this stems from the unrealistically low bar posed by analyst estimates coming into the season — which also explains why companies missing EPS expectations have lagged by nearly twice the typical historical average:

On balance, tariff uncertainty is dulling the shine of the impressive AI-driven results, and breadth is diminishing. Societe Generale’s Andrew Lapthorne points out that S&P 500 top 10 stocks represent 40% of the index’s market cap, and one-third of overall profits. More than half of those reporting to date have seen profit margins decline, even as more companies report rising sales. The divergence between increased sales and higher profits as shown in the following SocGen charts is unusual, Lapthorne says. A plausible explanation is that companies are bearing the weight of tariffs rather than passing it to customers:

Still, earnings call analysis shows that Corporate America is confident it can ride the tariff storm. More than half of companies providing full-year EPS guidance have raised it, nearly double the rate in the first quarter. Kostin also notes that breadth, the share of upward compared with downward revisions, is its widest since 2021. Of companies who discussed tariffs, 27% explicitly stated they now expect the profit headwind to be smaller than their previous estimates.

Another takeaway is that even among tech behemoths, breadth is shrinking. Microsoft Corp. and Nvidia Corp. earnings, due later this month, lead the pack. This polarization, as BCA Research’s Dhaval Joshi describes it, follows their almost 20% surge to new all-time highs. For context, Apple Inc. has shed $700 billion in market cap, falling almost 20% from its peak. A slump of such magnitude should be troubling. 

This trajectory suggests a potential reversal isn’t far off, Joshi argues:

Too many long-term investors have become short-term investors. So, when one of these long-term investors has second thoughts and wants to exit the trend, there will be no liquidity at that price. The only type of investor left to take the other side will be an ultra-long-term value investor, who will require a dislocation in the price.

The consensus that AI adoption is integral to productivity remains but, as BNY’s Bob Savage notes, it’s not unwavering. Continued strength will require proof that it can deliver higher productivity for the other 493 shares outside the Magnificent Seven. The hope for the third quarter is that the return on investments in AI bleeds into the rest of the S&P 500. Any further delay would test investors’ patience.

—Richard Abbey

Survival Tips

A discovery from a couple of weeks on the road. Freed From Desire by Gala has become an almost universal sports anthem. England’s Lionesses sang it to celebrate their European championship; Sparta Prague fans sing it every time their team scores. Neil Diamond’s Sweet Caroline is even more ubiquitous. I think it used to be specific to the Red Sox; now it’s played at soccer and even cricket games, and has even been translated it into Czech. Neither song is about sport or victory. Why so popular? Any other anthems to nominate? And have a great week everyone. 

More From Bloomberg Opinion:

• Kathryn Anne Edwards: The Bureau of Labor Statistics Is Not the Problem
• Robert Burgess: Tariffs? In This Economy? Good Luck With That
• Adrian Wooldridge: What If the US Isn’t the World’s Most Innovative Country?

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