Last week ended with a boost for the US economy as jobs data exceeded expectations, leading to a rise in bond yields as anticipation of a further jumbo rate cut from the Fed weakened.
As traders mulled the potential medium term impact of a labor report that shows 254,000 jobs were added in September, there is renewed talk of a scenario where the US economy not only avoids recession but continues to grow such that upward inflationary pressures limit the Fed’s ability to make cuts.
Late Sunday, Goldman Sachs chief economist Jan Hatzius updated the firm’s outlook for recession, given the latest signal of US economic resilience, with jobs created coming in well above the median expectation of 140,000 and the previous month’s total also revised higher by 72,000.
“We have cut our 12-month US recession probability back to the unconditional long-term average of 15%,” he said, adding that the data “reinforced our conviction” that the Fed will slow the pace of its interest rate cuts to 25 basis points in November.
Early Monday, the yield on the benchmark 10-year US Treasury reached 4% for the first time since August, and the 2-year yield was not far behind.
Traders are now considering how a ‘no landing’ scenario would play out, or the worse situation where inflation requires restrictive monetary policy from the Fed.
“The pain trade was always higher-front end rates due to less rate cuts being priced in,” George Catrambone, head of fixed income at DWS Americas told Bloomberg. “What could happen is the Fed either delivers no more rate cuts, or actually finds itself having to raise rates again.”
For equities, Morgan Stanley’s Michael Wilson believes the jobs data is positive for the market and may particularly benefit smaller US stocks as fading recession fears boost sentiment and business activity.
“We continue to believe we’re in a ‘good is good’ environment in terms of the equity market’s response to the labor/economic growth data,” Wilson wrote in a client note. “The bond market is becoming less skeptical on the soft landing outcome, an important signal for equity investors.”
However, José Torres, senior economist at Interactive Brokers, is more cautious.
“Stocks initially surged at the sound of the opening bell in response to dwindling recession concerns, but they have aggressively pared back those earlier advances in light of market participants no longer anticipating another 50-bp reduction from the Fed this year. Furthermore, the long end is yelling that the central bank won’t be able to lower fed funds to 3%, leaving the terminal rate to land 50 to 100 bps higher than current projections,” he said in his latest IBKR Economic Landscape.
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