The markets took a beating yesterday when word of increased labor costs sparked fears the Fed will raise interest rates as soon as next month.
The government reported the biggest jump in the cost of labor in eight years. The cost of wages and benefits rose a startling 1.1 percent in the second quarter – up from 0.4 percent for the preceding period.
Fed Chairman Alan Greenspan is known to pay particular attention to cost of labor numbers as an indicator of inflationary pressure, and the Street had been expecting the number to be about 0.7 or 0.8 percent.
The Dow Jones industrial average closed down 180.78 points at 10,791.29 – a drop of 1.65 percent – while the broader S&P 500 Index ended at 1,341.03, off 1.78 percent or 24.37 points.
The tech-heavy Nasdaq Composite Index, which is especially sensitive to interest rates, spiraled down 2.43 percent or 65.83 points to close at 2,640.01.
In addition yesterday, data came out indicating that investors cut their purchases of stock mutual funds in July to $7.6 billion in July, down from $19.2 billion in June.
The benchmark 30-year Treasury bond fell 3/4, or $7.50 per $1,000 face value, to end the day at 8826/32.
The falling price pushed the bond’s yield up 6 basis points to 6.07 percent, having reached a month-long high of 6.12 percent in earlier trading.
To make matters worse, it was coupled with lower-than-expected numbers for the gross domestic product, which grew at a 2.3 percent annual rate for the period.
“It’s not a good combo,” said Charles Pradilla, chief investment strategist for SG Cowen.
“If you have the possibility of higher short-term rates against mediocre growth – which is below expectations by at least percent – it’s the old 1-2 punch.”
“They were bad numbers and they put the fear of Greenspan tightening in people’s minds again,” he said
The rate-setting Fed Open Market Committee raised rates by a quarter percent at its last meeting on June 30 but the markets cheered when Greenspan removed a “bias” towards a further tightening of the money supply.
But Greenspan has sent warnings he may have changed his mind recently by making bearish comments before Congressional committees.
Fed-watching is a favorite pastime of economists and traders and the mixed signals mean there is little consensus on whether the FOMC will tighten again when it meets on Aug. 24.
“There must be 100 economists guessing and I think it’s 50/50,” Pradilla said.
Investors in interest-rate sensitive sectors – such as technology and financial services – were taking no chances and they led the sell-off.
J.P. Morgan fell 33/8 to 1305/8 while Microsoft ended the day at 8615/16, off 31/16.
Declining issues led advancing ones 11 to 4 and only 4 of the 30 Dow industrials were up.
Pradilla said some of the selloff can also be attributed to investment managers deciding to cash in. “A lot of people have made a lot of money so they’re getting more cautious and some portfolio managers are taking a little off the table,” he said.
The three major indexes last set record highs on July 16 but the Dow is down 3.7 percent since, while the S&P is off 5.5 percent and the Nasdaq down 7.8 percent.