Jobs-Day Shocker Vindicates Great Risk Rally of 2024

(Bloomberg) — The ever-resilient US economy is once again causing havoc for Wall Street worrywarts, who have sounded the recession alarm all year.

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After months of heated debate between stock and bond bulls on whether restrictive Federal Reserve policy would spur a downturn, a report showing the biggest gain in American hiring in six months spurred violent reversals in fixed-income markets that had gone all-in on a slowdown.

Small-cap companies led the cheer Friday as the dogged resilience of the US labor market underscores vigor in the domestic investment and consumption cycle. A long-dated Treasury exchange-traded fund capped the worst week since April, after rallying alongside equities and corporate bonds for months. Tech stocks bounced Friday, while bets on extra-large interest rates cuts were hastily re-thought.

It was just one day and the S&P 500 was broadly little changed this week amid growing concern about the Middle East war and threats to global supply lines. Warnings that inflation’s threat still lingers ahead of a key consumer-price report next week also bred caution.

But for skeptics clinging to views that anything short of drastic Fed action doomed the economy to an imminent contraction, the 254,000 gain in nonfarm payrolls was taken as evidence they’d pushed their wagers too far.

Cue vindication for risk-asset bulls who have defied the pessimists — and won — week in, week out. That’s emboldening the likes of HSBC Bank Plc’s Max Kettner. He’s telling clients to remain “aggressively overweight” equities around the world, high-yield debt and emerging-market bonds.

“This report reaffirms our very bullish stance on risk assets,” said the chief multi-asset strategist. “Continued rate cuts, low earnings expectations heading into the Q3 reporting season and continued strong US activity data all paint a very rosy picture for risk assets for the coming weeks.”

Signs the US economy is in less trouble than feared sent the dollar on a tear, and pushed yields on 10-year Treasuries to 3.97% at week’s end, reversing a drop since early August. Besides Friday’s employment report, a slew of recent data — including private-sector job numbers and a measure of the services sector — painted a rosy picture of the US economy.

Stocks crept higher Friday, but upside was limited by speculation the data will bolster hawks at the central bank, as well as a rise in bond yields that may augur poorly for the housing market. All told, the S&P 500’s 35% surge over the last year has pushed earnings-based valuations to rich levels, a potential brake headed into the US presidential election.

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Still, the surprisingly strong employment report was vindication for equity proponents, who have twice dragged the large-cap index back from losses spurred when July and August hiring missed forecasts. Quick cross-asset retrenchments underline the wide gap separating stock and bond investors over the future of the economy, with the latter whittling down bets that had sent 10-year yields to over a full percentage point lower since April.

“We are viewing the move in Treasuries as a pragmatic retracement of some of the growth worries markets have been focused on since that soft labor market data released at the start of August,” said April LaRusse, head of investment specialists at Insight Investment. “Clearly the US economy has more strength to it that some investors were betting on.”

As far back as Silicon Valley Bank’s collapse in March 2023, investors who leaned too far into economic bear cases have often been punished. The S&P 500 has rallied past the highest year-end target offered by Wall Street prognosticators in Bloomberg’s January survey. And strategists from Deutsche Bank AG’s Binky Chadha to BMO Capital Markets’ Brian Belski have been forced to boost their views to keep up.

In equities, nearly $500 million was sent for four straight weeks into an amped-up exchange-traded fund designed to win big when the Nasdaq 100 drops. That fund has since fallen by some 17% for the past month. A similar result befell those who recently dived into trades that gain when volatility goes up, from vanilla options hedges to more complex black-swan portfolio insurance. In each case, owners paid a steep price as soft-landing hopes prevailed.

Friday’s jobs data prompted economists at Bank of America Corp. to trim their forecast for the Fed’s November interest-rate cut to a quarter-point. “Another 50-basis-point cut isn’t warranted,” they wrote Friday. Analysts at JPMorgan Chase & Co. who accurately predicted a half-point reduction in September on Friday also trimmed their bet to just 25 basis points in November.

Swap contracts are pricing in only about 54 basis points of cuts for November and December combined — a drop of roughly 10 basis points after Friday’s number.

The Fed last month kicked off its widely anticipated easing cycle with a half-point rate cut, a move historically reserved for a recession or a market crisis. This time, the outsize reduction comes amid few obvious signs of stress. The Citi Economic Surprise Index has improved in last three months, entering positive territory again.

“For stocks, we think this is the best scenario — rates that are going to fall, and growth that isn’t falling off a cliff,” said Steve Chiavarone, senior portfolio manager and head of multi-asset at Federated Hermes. At the same time, he said, a single jobs report isn’t proof the Fed acted rashly with its first easing.

One component of the employment report, wage growth, gave pause to analysts worried inflation remains sticky. The higher-than-expected reading came as oil posted a big gain, while nickel surged after China unleashed a wave of stimulus that propelled its stocks into a bull market.

“This point is being incredibly overlooked today, that China was exporting deflation through industrial metals prices as their economy, real estate market and consumer base was weakening,” said George Cipolloni, a portfolio manager at Penn Mutual Asset Management. “In the past week, China has flipped that script with its significant and huge stimulus which has led to a move up in many major industrial metals.”

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