For the stock market, bad news is back to being good. Here’s why, says a Goldman Sachs economist

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It’s arguably the last important week for the stock market this summer (with the possible exception of the Jackson Hole Fed gathering at the end of August) with payrolls data as well as Amazon and Apple earnings on tap.

About midway through last week’s Federal Open Market Committee press conference, Chair Jerome Powell started talking at length about how the central bank could shift to cutting interest rates.

“The federal funds rate is at a restrictive level now. So, if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore, we can, you know, we can move back to a neutral level and then below a neutral level at a certain point,” he said. Naturally, he added that the Fed “of course would be very careful about that,” but he continued: “you’d stop raising long before you got to 2% inflation and you’d start cutting before you got to 2% inflation too.”

That’s a useful backdrop for the latest macro advice coming from Goldman Sachs, on how to trade a soft landing. Economist Spencer Hill finds that the stock market sensitivity to inflation news is now 12 times the historical norm.

“We view the market’s outsized focus on inflation data as consistent with our forecast of a hold at both September and November meetings, because we expect a further decline in inflation to more than offset resilient labor market data and continued positive GDP growth in the eyes of the Fed. Looking further ahead, we continue to expect above-average sensitivity to price and wage data, because progress on the ‘last mile’—the task of lowering inflation into the low-to-mid 2% range—will be crucial for the FOMC’s decisions to stop hiking and eventually begin cutting,” he says.

But even as the market gets excited by the idea of a soft landing, growth surprises aren’t well received. One recent example was the June retail sales report, which generated a strongly negative reaction in S&P futures over the next 30 minutes. In fact what markets are doing is returning to a “bad is good” reaction. “As fears of an imminent hard landing abate, equity investors may actually prefer soft growth data—because growth above the 1-2% channel of 2022 would make additional rate hikes more likely,” says Hill.

That of course is not the first time Wall Street has reacted more positively to bad data than good, with Hill saying summer 2023 has echoes of 2000 and early 2001. “We expect these ‘perverse’ equity reactions to growth data to continue as long as recession fears are on the back burner and the Fed maintains an active tightening bias—which is to say, ‘live’ meetings,” said Hill.

Keep the bad is good mantra in the back of your mind as the ISM manufacturing report and job openings data gets released on Tuesday and the nonfarm payrolls report gets unleashed on Friday.

The markets

U.S. stock futures?ES00,?0.20%?NQ00,?0.16%?inched higher, capping off a month in which the S&P 500?SPX,?+0.99%?so far has gained 3%. Crude oil futures?CL00,?1.28%?were trading above $81 a barrel, while the yield on the 10-year Treasury?TMUBMUSD10Y,?3.980%?was just shy of 4%.

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