Stocks rolled over again on Friday after a larger-than-expected drop in the unemployment rate to 5.1 percent in August increased the odds of an interest rate hike from the Federal Reserve at its Sept. 17 policy announcement. If that happens, it would be the first such move since 2006.
The Dow Jones industrials closed down 272 points, or 1.7 percent, to 16,102. That was 75 points above the day's low of 16,027 but still closing back in on the psychologically important 16,000 level. If the May 2010 "Flash Crash" is any guide, the Aug. 24 "Black Monday" lows should be exceeded in the coming weeks as the market tries to scare the Fed out of tightening monetary policy.
Friday's jobs numbers increased the odds of a September rate hike, according to the futures market, to around 35 percent. For now, based on comments from Fed officials, market participants believe recent stock market turmoil will keep zero percent interest rates in play.
Whether that's true depends on how Fed Chairman Janet Yellen and her cohorts interpret the latest read on the labor market. While the unemployment rate dropped to a level not seen since April 2008, only 173,000 jobs were created, missing the consensus forecast for 223,000. The result was also below the five-month average of 211,000 and the previous six-month average of 282,000.
Clearly, the job market has lost a little of its verve.
Offsetting this was strong wage growth, with average hourly earnings up 0.3 percent to take the year-over-year increase to a 2.2 percent rate.
If the Fed decides to postpone rate liftoff, it will truly enter unchartered territory. Coming out of the 1990-1991 recession, rate hikes started when the unemployment rate dropped to 6.6 percent. Coming out of the 2001 recession, rate hikes started with the unemployment rate at 5.6 percent. Today, even with the jobless rate at 5.1 percent, Wall Street doesn't believe Yellen will take action.
Why then are stocks falling so hard?
It's a little like the chicken-and-the-egg problem. Stock traders are worried about end of zero percent interest rates, which have been in place since 2008, now that the jobless rate has hit the Fed's median estimate of the "full employment" level. By at least one metric, the job market has finally fully healed from the recession.
Yet, along with still-soft inflation measures, Fed officials are worried about the impact a rate liftoff will have on market stability. With equity investors this nervous, the Fed may well decide to hold off until its October or December policy meetings, kicking the can on policy normalization one more time.
Paradoxically, by selling now stock bulls could be setting the stage for a strong "no hike" rebound later this month. But if they're wrong, and the Fed hikes anyway in September, they're getting out of the way of what's likely to be continued market turbulence as Fed tightening mixes with other negatives such as weakness in China, low commodity prices and pressures on corporate profits.
Wall Street economists are doing their best to explain this twisted logic to clients. Consider this excerpt from research out of Bank of America Merrill Lynch:
"In our view, this report clearly shows 'some' further improvement in the labor market, leaving the Fed comfortable starting the hiking cycle in September. We therefore are holding to our call that the Fed will hike on the 17th, but be sure to emphasize the gradual nature of the cycle."
"However, the market has to cooperate; they don't want to hike in the face of significant turmoil. Our baseline call for September remains, but we acknowledge the risks of a 'tactical' delay to October or December."
Put simply, no one really knows where the Fed will take interest rates later this month. And that uncertainty is making investors mighty nervous.