May ISM Services PMI topped expectations, coming in at 53.8 against the expected 51. The print comes after this morning's ADP National Employment Report showed private payroll growth slowed in May. FS Investments Chief US Economist Lara Rhame and Citi Global Equity Strategist David Groman join Catalysts to break down how the markets are digesting these economic indicators and what they could mean for the Federal Reserve's next interest rate decision.

Rhame explains that despite the mixed data out today, the Federal Reserve will be looking for hard data to confirm the state of the economy. She says May's jobs report — which will be released on Friday — is a particularly important data point. Groman adds that despite some of the volatility, the market isn't overreacting: "I think obviously expectations are baked in. It's quite elevated on the earnings side, especially in the US. But at this point, again, the reason that we think that where markets are trading right now still makes sense and why we think that you can still be a little bit constructive from here, at least outside the US, again, is on the fundamental side, which I think is an anchor here."

In terms of the Fed's next interest rate move, Rhame notes that the current economy is strong, "so against that backdrop, there's no urgency for the Fed to cut rates. I think they want to get it done. I think it may not happen until after the election, and today's data doesn't really change my view of that." She believes that a rate cut could come in November or December, adding, "if our economy does slow a lot, the Fed has room to cut significantly."

For more expert insight and the latest market action, click here to watch this full episode of Catalysts.

This post was written by Melanie Riehl

Video Transcript

May Im Services PM I coming in at 53.8 versus the 51 that was expected.

Stocks are mixed on the news.

The dow is moving to the downside here.

The S and P 500 pairing back some of its gains from earlier today.

Looking at 2/10 of a percent of growth and NADA holding on to gains of about 7/10 of a percent here.

The market react to this data as well as softer than expected private payrolls this morning.

Joining us now to discuss all of the incoming data, we've got LA Ra chief US economist at FS Investments also joined by David Groman.

He is Vice president on the Global Equity strategy team at city.

Thank you both for being here.

Laura, I've got to start with you a slew of data coming in this morning.

What is standing out to you?

What stands out is the fact that some of the survey data continue to really give us mixed messages.

Story continues

We have the downside surprise in the manufacturing PM I earlier this week, which really just it gave us a lot of uh I think gave markets a lot of hope the fed was going to be considering rate cuts in the second half of the year, much more seriously.

But today the I the services ism has been stronger than expected.

We really just need to wait for that payrolls number.

I think the message that we come away with today is that surveys are still kind of pointing in multiple different directions and that the fed is going to be looking for the hard data to confirm whether the economy is still hot or whether it's really much at a pace that they can cut rates against.

Yeah, so hard data mattering a little bit more than survey data perhaps for the fed.

David.

Come on in here because as Laura was mentioning, we got to wait for payroll this Friday.

How much market volatility should investors be anticipating coming up on Friday?

Yeah, obviously it's a really important event for markets.

And I think we're really watching the data closely at this point because it really has an impact on what the fed will do and, and rates policy from there.

But I think the the point for us in the way that we're thinking about equities is that yes, the rate cuts will be good for equities when they come, potentially, if they come a little bit later than expected, it could be a headwind.

But ultimately, we are still pretty constructive and that becomes uh the reason for that is the fundamental outlook which still looks really, really strong last year earnings slow down this year, earnings looking to be much better.

And we've seen an inflection here after the, the recent reporting season as well.

So remaining constructive on the fundamental side sticking with you here.

I am curious and I heard a guest say recently that the fed is a reaction function.

The market has an over reaction function right now, David.

Would you say that the market is overreacting to each data print?

Yeah, I wouldn't say that it's overreacting at this point.

I think obviously, expectations are, are, you know, baked in, it's quite elevated on the earnings side, especially in the US.

But at this point again, the reason that we think that where markets are trading right now still makes sense and why we think that you can still be a little bit constructive from here, at least outside the US again, is on the fundamental side, which I think is an anchor here.

Again, earnings expect to be better and broader.

This year, we've seen a clear inflection, at least in the US and in Europe, in terms of upgrades starting to come through now.

So there's a reason to still be constructive for the market to keep moving.

Obviously, these data points matter a lot, but really focus on the fundamentals.

Well, Laura, as you were kind of mentioning, we've got a lot of mixed data here and it's interesting to see what we're seeing in the treasury space.

I'm just taking a look.

The two year Treasury briefly spiking off that IM data even though it was pretty mixed.

So interesting to see the reaction in the treasury space.

What does this do to your outlook for the Federal Reserve does today's data even though it was mixed increase, what you anticipate as the pace of that cuts today said it doesn't really change my outlook, which is that the fed wants to cut interest rates, that it may have trouble getting that done.

We have the election calendar which while the fed is independent, let's be honest, it actually does matter and we have the fact that inflation is still stubbornly high.

And finally, I think we, we've talked about fundamentals that's really important.

The economy today looks strong that powers earnings in publicly traded equities, but it's also powering the rest of our economy.

The 200,000 middle market companies that really are the big engine of the US economy and growth are looking good.

So against that backdrop, there's no urgency for the Fed to cut rates.

I think they want to get it done.

I think it may not happen until after the election.

And today's data doesn't really change my view of that.

It's actually a good market right now.

It's a good market right now, particularly in the last 10 minutes of the trading day.

As I keep saying, David, how would you describe what the market is able to do right now.

I keep saying that it is sort of just grinding out gains in that final 10 minutes of the day.

What would your description be of what the market is able to do all of this data?

Yeah, I think when we take a broader view, I think the thing that's really important is where expectations are and kind of what the market is pricing in for those expectations.

Right.

So if you look in the US, what our models are telling us is the market is pricing in sort of an earnings outcome, that's actually above where consensus analysts are.

So really there is this sort of beat and raise dynamic that is built into the price of us equities.

So again, we're talking about fundamentals, you really do need to continue to upside there when we look at the rest of the world European equities for uh for certain, right, like there are better expectations price in than at the beginning of the year, but they're more in line with where analysts are.

So I think the European market reservoir equity is more fairly priced in the US.

You definitely are still looking for this beat and raise mentality.

And obviously the economic data plays a role in how possible it is for companies to achieve that.

And laura ending with you here, over half the market pricing and a cut in September, you mentioned the importance of the election though to what extent do you think the election bars, the fed from cutting in September?

You know, when you look at the calendar, we are kind of running out of meetings.

I don't think anybody expects them to cut in June.

So it really puts the July meeting in focus if they were to wait until September, that is the meeting before the election.

And I think that does get a little bit tricky politically again.

We would love to live in a world where that doesn't matter.

But I think today we kidding ourselves to think that it doesn't matter.

Uh, I think the fed would like to either think of July or think of sort of after the election and to really manage a rate cut in July.

I think you'd need to see an unemployment rate above 4% and some really kind of low numbers on the inflation piece.

I don't think we're gonna get it.

And I think to the extent that the fed wants to cut rates going to have to wait and do it in either November or December.

Well, Laura ending with you finally here, the Bank of Canada just cutting rates.

The European Central Bank widely expected to cut rates tomorrow.

I'm curious from your perspective, what it means when we start to have a divided world when it comes to central banks cutting back on rates.

What does that mean for us?

In the US?

It's certainly different.

Usually the fed is the leader, not the follower, but you know, it does.

I think the FED is aiming the direction is dovish.

They want to cut.

It's just a matter of timing.

So to me this really just reinforces the positive fundamentals that are out there.

If our economy does slow a lot, the FED has room to cut significant.

The fact that they haven't just is really a reflection of the strong economy that are sustaining fundamentals for growth and for company earnings.

All right, we're gonna have to leave it there.

I really appreciate you both joining us.

That was Laura Rae.

She is Chief US economist from FS Investments.

Also David Groman, he is city's global equity strategist.

Joining us.