The month of August is usually a sleeper on Wall Street, which is why it’s often referred to as the Dog Days. Traditionally, the big players go off to their vacation homes and the junior staff minds the shop. As a result, the conventional wisdom is that little happens as the dogs nap for the month.

On the other hand, traditions have been thrown out the window in this market as the program trading algos never take vacations, especially when it comes to responding to big data releases.

All of which brings me to this week’s big number, the July employment report which is due out on 8/4/23. This number may well be a big market mover, especially in the bond market, where yields have been climbing of late. Even if no one’s home, the algos never sleep, so the market will move.

As I’ve said before, forecasting is a fool’s game, but the expectations are for 200,000 new jobs created in July to go along with a 3.6% unemployment rate and a slowing in wage growth. Anything that strays above or below those numbers meaningfully is likely to trigger big algo buy or sell programs which will ripple through the markets.

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Certainly, over the last few months, the government’s employment data has indicated a strong jobs market, while private surveys and anecdotal data have been less positive and more volatile. For example, the employment component of the purchasing manager reports, such (ISM and PMI) have been heading down lately.

Specifically, the PMI Manufacturing survey for July came in at a reading of 46.4, a sign that the manufacturing sector is contracting since readings below 50 are negative. Inside the report, the new orders and employment components were also below 50, suggesting that the economy is not as strong as the mainstream view.

Cited among the reasons for the weakness were:

• A decline in new orders;
• A fall in order backlogs as client spending is decreasing since they face decreased demand from retail customers;
• Marginal rises in raw materials; and
• Stable selling prices (aka, the inability to raise prices and pass on costs to customers).

Declining orders, a future decline in inventories in the face of falling future demand, and low pricing power may be emerging as the new norms for the manufacturing sector. That sounds as if inflation may be cooling and a recession is looming, even as firms are holding onto qualified workers, and in some cases hiring in expectations of better times ahead.

For its part, the ISM Manufacturing Survey paints a similar picture, while adding that due to weak demand, “there are signs of more employment reduction actions in the near term to better match production output.”

In addition, the most recent job opening data, the JOLTS, shows that job openings are falling along with the number of workers who are willing to quit in order to find another job. This willingness by workers to keep what they have is supported by recent reports such as the demise of shipping company Yellow Freight and its projected 30,000 job losses, while CVS Health (NYSE: CVS) is planning 5,000 job cuts.

The private payroll numbers from ADP delivered better-than-expected numbers, with 324,000 jobs added. The only two losing sectors were financial services and manufacturing. Meanwhile, the Challenger, Grey, and Christmas layoffs numbers for June showed a 49% reduction in layoffs.

No one really knows what’s happening.

If the Economy is Weak, Why are Bond Yields Rising?

Familiar readers are well versed in my obsession with the U.S. Ten Year Note yield (TNX). That’s because this market interest rate is the benchmark for mortgage rates, which are tied to the housing industry and its 11%-15% contribution to U.S. gross domestic product.

When bond yields rise, it’s usually a sign that bond traders are fretting about inflation, which eats away at the return on their fixed income bond. For example, if inflation is rising at 6%, and your bond yields 4%, you are two percent under water on your spending power.

As the TNX price chart above shows, bond yields have been creeping up of late, even as the most recent consumer and producer prices (CPI and PPI) have cooled off. Most recently, the Federal Reserve’s favorite inflation gauge, the PCE Deflator, delivered a rather quiet reading. My big concern is that 4% is no longer a resistance level.

The answer may lie in a combination of converging factors. First in line is the daily gyrations of real life commodity markets, specifically, energy. Let’s start with crude oil prices.

As the chart above shows, West Texas Intermediate Crude (WTIC) had quietly crept up above $80 per barrel, which I predicted in May. The most recent oil inventory data posted a 17 million barrel crude oil draw for the week of July 28, 2023 as refineries increase gasoline and diesel production while diesel and related inventories remain 15% below the five year average.

The market initially sold off on the news, as gasoline demand has slowed. The key price level here remains $80/bbl.

Interestingly, the slow and steady decline in oil production has now bled into the gasoline market (GASO), which had quietly risen nearly 50% since bottom out in December 2022 prior to the reversal on 8/2/23.

On the other hand, it’s difficult to gauge what’s next for the oil patch as drilling is slowing, and it’s not certain whether the huge drop in inventories was a one-off event or the start of a new trend.

As I noted here last week, the potential for scarcity in other commodities such as wheat and corn due to volatile weather patterns and the repercussions of the increasingly active war in Ukraine are rising. The latter may just be getting started, as reports of Russia considering adding tariffs to fertilizer exports recently surfaced.

But perhaps the bond market’s biggest fear is the bond market itself, and its response to what is expected to be the first in many increases in government bond issues and a likely increase in the U.S. budget deficit.

That’s because an increase in Treasury bond sales will increase the supply of bonds, especially bonds which may have a higher yield than other bonds in circulation. As a result, dealers may opt to sell their current bonds to replace them with higher yielders.

Adapting to Changing Conditions

Complex systems adapt. And as I noted last week, stocks in sectors with tight product supplies, such as energy, are taking the rise in bond yields in stride. You can see this in places where you would not expect it such as oil refinery companies and shares of companies in out of favor industries.

One example are the shares of oil refiner HF Sinclair (NYSE: DINO). Sinclair is currently benefiting from the higher refiner margins caused by the squeeze in crude production and the steadily rising gasoline supplies in the face of stable, and perhaps rising gasoline demand.

The stock is in a solid accumulation pattern illustrated by the Accumulation/Distribution Indicator (ADI) and On Balance Volume (OBV) lines, which are rising as money moves in. The stock has just crossed into bull market territory by climbing above its 200-day moving average.

Another unexpected beneficiary of the slowly emerging energy squeeze oil tanker operator Scorpio Tankers Inc. (NYSE: STNG), which is on the verge of a bullish cross-over of its 200-day moving average. The rally in STNG may just be getting started as the ADI and OBV lines have just turned up.

Scorpio is likely to benefit from higher fees if the situation on the high seas deteriorates due to an increasingly uncertain geopolitical climate.

Bottom Line

The economy, along with the bond, commodities and stock markets are in a transitional spot.

The July employment report will likely affect the current calculus in both the stock bond markets. Specifically, any sign of pronounced weakness in the labor market could well reverse the recent rise in yields and rekindle the rally in stocks. Unexpected strength will likely lead to higher bond yields.

Prior to the release, bond traders are handicapping the effect of a supply increase on their portfolio.

Simultaneously, the stocks of companies whose products are in tight supply are rising, as traders factor in higher potential profits.

My biggest worry is that the 4% yield for TNX becomes a bottom. This would reverse its recent role as a top for market interest rates. That would likely not play well in the stock market.

PS: Does all this uncertainty have you on edge? The key to mastering risk resides in what my colleague Jim Pearce calls “Mayhem Trades.”

Jim Pearce is chief investment strategist of our premium trading service, Mayhem Trader. Jim has developed an under-the-radar strategy to flip market mayhem into fast payouts. Want to learn more? Click here now.

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