Stocks and Bonds Rise as Fed Bets Are Fueled by Weak Data

Wall Street traders pushed stock prices higher and bond yields fell after a series of weaker-than-expected economic data bolstered the case for the Federal Reserve to start cutting interest rates this year.

‍

In a shortened trading session ahead of the U.S. holiday, the S&P 500 was on track for a new all-time high, driven by expectations that Fed policy easing would continue to benefit Corporate America. Treasuries gained across the yield curve as data revealed that the U.S. services sector contracted at the fastest rate in four years, private payroll growth slowed, and continuing jobless claims rose for the ninth consecutive week.

‍

Further insight into the labor market's health will come with the release of the monthly employment report on Friday. Economists predict a gain of 190,000 nonfarm payrolls, a decrease from the previous month.

‍

“If the data cooperate, we believe a September cut remains very much in play,” said Win Thin and Elias Haddad of Brown Brothers Harriman & Co.

‍

Treasury 10-year yields dropped nine basis points to 4.34%. Swap traders are forecasting nearly two rate cuts in 2024, with the first anticipated in November, though expectations for a September reduction have increased. The dollar was headed for its biggest decline since mid-May. The S&P 500 hovered around 5,520 points. Tesla Inc. saw a rally, while Amazon.com Inc. experienced a decline.

‍

Fed Chair Jerome Powell indicated this week that recent economic data suggest inflation is moving back on a downward trajectory, but he stressed that more evidence is needed before the Fed can start lowering interest rates. When asked what keeps him up at night, he highlighted the challenge of balancing inflation control with avoiding significant deterioration in the labor market.

‍

Meanwhile, Fed Bank of New York President John Williams, who has extensively studied the natural rate of interest known as r-star, countered recent claims that it has risen since the pandemic.

‍

The concept of the long-run natural rate of interest, which prevails when the economy is not reacting to shocks and is growing at its potential, is central to monetary policy but cannot be directly observed. Officials aim to raise rates above this neutral level to cool the economy and combat inflation.

‍

The latest economic data include a report showing the U.S. services sector's contraction at the fastest rate in four years, suggesting a cooling economy. Additionally, private payrolls rose at a slower pace, and continuing jobless claims increased for the ninth consecutive week, indicating potential softening in the labor market.

‍

Economists are watching closely for the upcoming monthly employment report, which is expected to show a gain of 190,000 nonfarm payrolls. This would be a step down from the previous month, reinforcing the narrative that the labor market is slowing.

‍

Win Thin and Elias Haddad of Brown Brothers Harriman & Co. suggest that if the data continues to support this trend, a September rate cut by the Fed remains a strong possibility. Treasury yields reflect this sentiment, with the 10-year yield falling to 4.34%. Swap traders are betting on nearly two rate cuts in 2024, with an increased likelihood of the first cut happening in September.

‍

The dollar is on track for its most significant drop since mid-May, further reflecting market expectations of Fed rate cuts. The S&P 500 is maintaining its position around 5,520 points, benefiting from these expectations. Tesla Inc. shares have rallied, while Amazon.com Inc. shares have declined, reflecting sector-specific responses to the broader market trends.

‍

Fed Chair Jerome Powell emphasized the need for more evidence before the Fed can consider lowering rates, despite recent data indicating a downward trend in inflation. He pointed out the delicate balance between controlling inflation and avoiding significant negative impacts on the labor market.

‍

John Williams, President of the Fed Bank of New York, has pushed back against recent claims that the natural rate of interest, or r-star, has increased since the pandemic. The r-star rate is crucial for monetary policy but is not directly observable. It represents the rate at which the economy is growing at its potential without responding to shocks. Fed officials aim to set rates above this neutral level to cool the economy and combat inflation.

‍

In summary, weaker-than-expected economic data is fueling expectations of Federal Reserve rate cuts, leading to higher stock prices and lower bond yields. The upcoming employment report will provide further insights into the labor market's health, and market participants are closely watching for indications that could support or challenge the case for rate cuts.

‍