Initial jobless claims fell more than expected last week, with a big drop in Texas suggesting that the weak July jobs report was skewed by Hurricane Beryl. With recession fears easing, odds of a 50-basis-point Federal Reserve rate hike have fallen, but there's good reason for it to happen as the S&P 500 faces a period of tough sledding.
Jobless Claims Don't Signal Recession
New claims for unemployment benefits fell 17,000 to 233,000 in the week through Aug. 3, above economists' 240,000 forecast.
The ranks of people continuing to claim benefits rose 6,000 to 1.875 million in the July 27 week.
"Initial claims remain more consistent with a mild slowdown than a brewing recession for now," wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics. He noted that the decline in initial claims from the prior week "primarily was driven by claims dropping back in Texas, which bore the brunt of Hurricane Beryl in early July."
Still, Shepherdson expects the "upward trend in claims will steepen." He cites Cleveland Fed calculations showing that advanced layoff notices, or WARN notices, in June nearly hit the highest level since December 2020. The one higher month was August 2023, when trucking giant Yellow Corp. collapsed.
Fed Rate-Cut Outlook
As of Thursday morning, markets are pricing in 55.5% odds of a half-point Fed rate cut by the close of the Sept. 18 meeting, down from 69% on Wednesday and 100% during the height of Monday's market panic.
Odds of a full percentage point in Fed rate cuts this year slipped to 74% from 85.5% on Wednesday.
Recession fears do look overblown. Yet keep in mind that the Fed delayed a pivot to rate cuts from a very restrictive rate setting partly because of worry about an S&P 500 AI-fueled melt-up. Federal Reserve Chair Jerome Powell nearly said as much after the June meeting.
Stock Market Rallies As Jobs Data Surprises, But These Stocks Are A Sell (Live Coverage)
"When we do start to loosen policy, that will show up in a significant loosening in financial market conditions," Powell said at the time. "It's a consequential decision for the economy and you want to get it right."
Stock prices are a major contributor to financial conditions and the major reason why financial conditions had become looser than any time since the Fed started hiking in March 2022.
The upshot is that the Fed almost surely would have cut rates by the July 31 meeting if not for worries about a 1999-type stock market rally. After the Fed's first cut in late September 1998, the S&P 500 went on a 25% run over the next six months.
Now, the Nasdaq correction, fueled by a 27% sell-off in AI leader Nvidia, amid a technology hiccup and emerging concerns that the expense of AI processing may slow its uptake, should convince the Fed to stop playing defense and proactively ensure a soft landing for the economy.
S&P 500 Rebounds
The S&P 500 rallied 1.9% in Thursday morning stock market action, following the encouraging jobless claims data. On Wednesday, the S&P 500 added 0.8%, but still finished 8.25% below its record closing high on July 16. The S&P 500 was still up 9% for the year.
As of Wednesday, the Nasdaq remained in correction territory, down more than 13% from its July 10 record closing high.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
