"The bad news effect" reappears, the Federal Reserve faces challenges: Positive measures may not be able to timely curb the economic weakness trend

According to the report released on Thursday by Interactive Brokers (IBKR) Chief Strategist Steve Sosnick, the U.S. market is currently in a period of "bad news is bad news," which may put the Federal Reserve in an awkward position: even if it is prepared to take proactive monetary policy measures, it may not be able to respond promptly to actual economic weakness.

Over the past two years, the norm on Wall Street has been "good news is bad news." As the Federal Reserve embarked on its largest policy tightening action in decades, the market has been looking for signs of economic weakness. Therefore, strong economic data is not necessarily a completely positive signal for market participants expecting rate cuts.

However, the situation has recently changed. The market now widely expects the Federal Reserve to implement its first rate cut since the outbreak of the COVID-19 pandemic at the next Federal Open Market Committee (FOMC) meeting on September 18.

Sosnick pointed out, "With a rate cut almost a foregone conclusion, we are entering an environment where 'bad news is bad news'." He further explained, "The real risk is that bad news may cause the Fed's positive measures to come too late to prevent real economic weakness."

Nevertheless, he also mentioned that the market is concerned that overly positive economic data may delay the Fed's rate cuts as expected.

Sosnick stated, "The data-dependent Fed is unlikely to cut rates by 25 basis points at each of the remaining three FOMC meetings this year as the market expects."

Labor Market Data

Ahead of the highly anticipated non-farm payroll data release, the ADP employment data, also known as "small non-farm," unexpectedly slowed significantly, implying continued uncertainty in the U.S. labor market and further fueling expectations of a significant rate cut by the Fed in September.

On September 5, data jointly released by the ADP Research Institute and the Stanford Digital Economy Lab showed that the ADP employment in the U.S. only increased by 99,000 in August, hitting the lowest level since January 2021, well below the market's expectation of 145,000 and the previous value of 122,000.

Previously, the U.S. Department of Labor reported on Wednesday that job vacancies in July fell to the lowest level since January 2021. Meanwhile, outplacement firm Challenger, Gray & Christmas mentioned in its report on Thursday that layoffs in August were the most severe since 2009, and the pace of hiring in 2024 was the slowest in a year since tracking the data since 2005.

However, ADP's data also showed that despite the slowdown in hiring, several industries added jobs in August, with only a few reporting actual layoffs.

Following the ADP data release, initial jobless claims data for the week ending August 31 showed that 227,000 Americans filed for unemployment benefits for the first time, lower than the expected 230,000. The number of continued jobless claims for the week ending August 24 was 1.838 million, also lower than the expected 1.869 million, with both indicators decreasing from the previous values The downward trend may help alleviate concerns about the deterioration of the labor market.

The upcoming release of the August non-farm payroll report on Friday is expected to be a key indicator that will have a significant impact on market expectations for the size of the Fed's rate cut later this month.

Sosnick added, "The market is expecting a 'Goldilocks' employment report - neither too hot nor too cold."

Currently, the market generally expects an increase of 165,000 in non-farm payrolls in August, with the unemployment rate expected to remain at 4.2%. The results of this report will provide investors with important clues about the US economic conditions and the Fed's policy direction.

Expectations for a 50 basis point rate cut by the Fed are rising

Following the release of the August ADP employment data in the US, market expectations for a 50 basis point rate cut by the Fed in September have increased. According to the Chicago Mercantile Exchange (CME) FedWatch tool, the probability of a 50 basis point rate cut in September has risen to 45%.

Priya Misra, portfolio manager at Morgan Stanley Asset Management, pointed out, "The slowdown in the labor market has caught the Fed's attention. Considering that the federal funds rate target range is still relatively high at 5.25% to 5.5%, and the US economy is slowing down, coupled with the well-known long and variable lag effects of monetary policy on the economy, I believe there are good reasons to support an initial 50 basis point rate cut by the Fed."

Jonathan Cohn, head of US rate strategy at Nomura Securities, stated that there is a divergence in the market regarding the magnitude of the first rate cut in September, whether it will be 25 basis points or 50 basis points, which will largely depend on the results of the upcoming non-farm payroll report. He emphasized that if certain key thresholds are met in terms of unemployment and layoffs, the likelihood of a 50 basis point rate cut will significantly increase.

According to the schedule, the Fed's September interest rate meeting will be held on September 17th to 18th. The market generally expects the Fed to announce a rate cut at this meeting. While most analysts expect the Fed to stick to a 25 basis point rate cut, there are also views that a 50 basis point rate cut is possible.

Summary

IBKR's strategist emphasized that for most traders and investors, the key is to understand the market's reaction to different situations, not just the numbers themselves.

Fixed income traders seem to have already anticipated a 25 to 50 basis point rate cut in the next two weeks, but "significantly lower than expected" employment data could increase the possibility of further rate cuts. Sosnick warned, "Data that deviates significantly from consensus means many investors will face challenges. And when traders are in trouble, market volatility will increase."

For investors looking to track the Wall Street benchmark S&P 500 index, here are some ETFs worth watching: SPDR S&P 500 ETF (SPY.US), Vanguard S&P 500 ETF (VOO.US), iShares S&P 500 ETF (IVV.US), Rydex Equal Weight ETF (RSP.US), ProShares Ultra S&P 500 ETF (SSO.US), ProShares UltraPro S&P 500 (UPRO.US), ProShares Short S&P 500 (SH.US) ProShares UltraShort S&P500 ETF (SDS.US) and ProShares UltraPro Short S&P500 ETF (SPXU.US) offer double and triple short exposure to the S&P 500 index, respectively