US economic report shows divergence, market bears suffer setbacks

Wall Street traders faced another week of conflicting economic signals and painful lessons when dealing with the data-dependent Federal Reserve.

Amid concerns about inflation, traders withdrew funds from credit and cryptocurrencies, while reducing their exposure to stocks. However, these bearish investors suffered a blow when both the S&P 500 index and US Treasuries rose simultaneously for the first time in a month.

Federal Reserve Chairman Powell's positive remarks and soft job data propelled the stock market higher. Yet, divergent economic reports repeatedly caused investors to pay the price when betting on the Fed's next interest rate decision.

On Tuesday, a broad measure of US labor costs saw the biggest annual increase in a year, leading to the two-year US Treasury yield exceeding 5%. Three days later, a Labor Department report showed the smallest wage growth since 2021, causing yields to decline again.

Recent reports indicate a surge in retail sales, while US Gross Domestic Product slowed down. Industrial production rose, but manufacturing slowed. Unemployment claims remained steady, but hiring declined. For traders who are certain that every indicator could impact monetary policy decisions, this is very confusing, with the stock market's intraday volatility reaching its highest level since November.

According to a report from Zhitong Finance, Mohamed El-Erian, Dean of Queens' College at the University of Cambridge and Bloomberg columnist, said in an interview with Bloomberg TV on Friday: "People are worried that the Fed relies too much on data. This will exacerbate market volatility."

At least in the short term, bulls had the upper hand on Friday due to the data, and some of the froth evaporated from the market as day traders cashed in some profits.

Lindsay Rosner, Head of Fixed Income Investments at Goldman Sachs Asset Management, said: "The most important news this week is Powell's indication that a rate hike is 'unlikely'. Coupled with this morning's soft landing data, there are huge opportunities for yields."

The S&P 500 index rose by 0.6% this week, while the Bloomberg index tracking US Treasury yields surged, ending four consecutive weeks of decline. Intraday volatility deepened, with the 20-day average price volatility of the stock benchmark reaching its highest point since November.

Friday's jobs report showed that after a series of strong employment reports this year, demand for workers is slowing down, driving the S&P 500 index to its largest single-day gain since February. In the previous month, most investors withdrew from the market.

According to data compiled by Bloomberg Intelligence, stock and bond exchange-traded funds saw a net inflow of $32 billion in April, the smallest since August 2023. Traders cashed out $3.6 billion from one of the largest investment-grade credit ETFs in April as rising yields sparked fears on Wall Street about long-term assets. Citigroup's Levkovich Index, which depicts market sentiment by tracking indicators from options trading to short selling and fund flows, has just turned neutral after weeks of excitement Retail investors who had been eagerly anticipating a recovery in the first quarter are now showing signs of fatigue. According to data from less than 10 contracts quoted by Morgan Stanley, demand for bullish options in retail trading has dropped to its lowest level this year.

Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, said, "There has been a significant shift in options sentiment. The bullish frenzy peaked in early March. Compared to the YOLO/FOMO we saw before, the right tail has significantly weakened."

This lack of confidence is not limited to traders, as economists are also struggling to predict the direction of economic data, revising their interest rate targets every few months. Friday's employment data was significantly below Wall Street's expectations, with only 5 out of 61 economists surveyed by Bloomberg predicting an average hourly wage growth of 0.2%. The labor cost index rose by 1.2% on Tuesday, exceeding all expectations from the Bloomberg survey.

What are the results? As Powell continues to adhere to data-driven monetary policy this week, and economic releases point to imbalanced growth, quick-reacting traders find themselves constrained by conflicting data. However, for many, as high-quality assets continue to provide decent returns, short-term fluctuations are just a sideshow, which is good news for income-oriented investors.

Brian Rose, senior economist at UBS Global Wealth Management in the United States, said, "We expect inflation data to improve in the coming months, creating conditions for the Fed to start cutting rates in September. In our investment strategy, we prefer high-quality bonds."