Bank of America warns: Non-farm payrolls hold the power of life and death, and interest rate cut expectations may face major changes!

According to data from Bank of America, the biggest risk facing the stock market this week is the hot August non-farm payroll report compared to expectations.

Bank of America analysts stated in a report on September 2 that the non-farm payroll report has "become the most important data for the stock market" once again. S&P 500 index futures contracts are more sensitive to US employment reports than inflation data.

Since August 2019, the reaction of eMini S&P 500 futures continuous contracts to non-farm and CPI data has been observed from 5 minutes before the data release to 30 minutes after the release.

With inflation falling sharply from its peak in 2022, investors are now closely watching the labor market for signs of weakness. Bank of America emphasized in the report that overheating employment data will lead to a repricing of rate cut expectations for this year.

Bank of America strategist Ohsung Kwon said, "From the return of the stock market to near highs and the performance of small-cap stocks and equal-weighted S&P 500 index, the market seems more excited about the Fed's rate cuts this year than worried about a potential economic recession."

He added, "If this is true, then the main risk for the stock market this week is the unexpectedly strong non-farm payroll data, which will push short-term interest rate pricing higher (i.e., cut rate cut expectations)."

The August non-farm payroll report will be released on Friday morning. Economists expect the US economy to have created 162,000 jobs last month, which, if accurate, would bring the unemployment rate down from 4.3% to 4.2%.

According to CME's FedWatch tool, Bank of America economists expect the Fed to cut rates only twice this year, by 25 basis points each time, while the market expects a total rate cut of up to 100 basis points within the year.

If the US non-farm payroll report rebounds strongly from the soft trend in July, this could change market sentiment and prove that investors are overly confident in the Fed's rate cut path.

According to Bank of America's report, this could bring downward pressure to the stock market. Kwon suggests that investors hedge downside risks by using put options spreads on S&P 500 index expiring in October.

The latest signs of resilience in the US economy include the upward revision of second-quarter GDP growth from 2.8% to 3%, as well as robust personal spending data, which increased by 0.5% month-on-month in July.

According to Bank of America's report, "the economy continues to show robust momentum." Kwon said, "The economy continues to defy skeptics. Growth has certainly cooled compared to last year, but the cooling is gradual."

Data on Tuesday showed that US manufacturing activity remained subdued in August, leading to a sharp decline in major stock indices. In response, Thomas Ryan, North American economist at Capital Economics, stated in a report on the latest ISM Manufacturing Index, "Despite soft survey data, our tracking based on hard data indicates that US GDP will still maintain an annualized growth rate of 2.5% in the third quarter." Yardeni Research's Ed Yardeni is also one of the Wall Street strategists expected to release a hot employment report on Friday.

In a report to clients on Monday, Yardeni stated that he expects to add 200,000 to 225,000 jobs in August.

If this turns out to be true, it would surpass economists' estimates and align with the strong employment reports in May and June, thereby reinforcing the idea that the Federal Reserve does not need to cut interest rates significantly.

Yardeni said, "The Fed is unlikely to lower the federal funds rate rapidly and significantly as it did during the financial crisis, triggering credit tightening and economic recession."

While Yardeni's optimistic outlook is good news for the economy, it may serve as a short-term resistance to stock prices