Non-farm unemployment rate did not shock, important Fed officials were dovish, why did US stocks plummet on Friday?

On Friday, September 6th, as the US Treasury yields continued to decline "as expected" due to the poor August US non-farm payroll data, the US stock market once again showed its "unpredictable" side. Initially opening higher due to increased rate cut expectations, it quickly dropped significantly.

Afternoon trading saw major US stock indices continuously hitting new daily lows, with technology and chip stocks closely linked to the AI trend leading the decline. The broad S&P 500 index fell nearly 100 points or 1.8%, the Dow Jones Industrial Average, dominated by blue-chip stocks, dropped over 430 points or 1%, the tech-heavy Nasdaq also fell 450 points or 2.6%, the Russell 2000 small-cap stock index, highly sensitive to economic cycles, fell 2%, and the "fear index" VIX rose over 17%.

This week, the US released several disappointing economic data points, indicating a continued cooling labor market, as well as a manufacturing sector still in contraction and a services sector showing only "moderate" expansion. This led investors to sell off risk assets and buy safe-haven US Treasury bonds amid growing growth concerns. The S&P index fell over 4% this week, the Dow fell nearly 3%, marking the worst week in a year and a half since March 2023, the Nasdaq fell nearly 6%, and US Treasury yields hit a new low of over a year.

Currently, major US stock indices are at their lowest levels in about four weeks since mid-August. The S&P and Russell small-cap stock indices have fallen for four consecutive days this week, meaning that since returning from the long weekend on Tuesday, they have been declining every day in the first trading week of September. Analysts widely believe that the latest non-farm payroll report has raised significant doubts, concerns about AI demand have also hit the tech industry, further deteriorating the stock market on Friday.

Market Focus on the "Poor" August Non-Farm Payroll, Intensifying Economic Slowdown Concerns, Suppressing Risk Appetite

The main reason for the decline in US stocks and rise in bonds on Friday was the poor August non-farm payroll data in the US. Although this data can be described as "mixed" overall and did not release completely pessimistic signals, it clearly revealed a trend of labor market cooling faster than expected, intensifying concerns about economic slowdown, and thereby suppressing investors' risk sentiment.

Specifically, although the addition of 142,000 new jobs in August is consistent with the recent average job growth rate, it has significantly slowed compared to the average increase of over 200,000 people in the past 12 months. Moreover, the revisions downward by a total of 86,000 for June and July not only created a tense atmosphere of labor market losing momentum earlier than expected but also brought the average new job additions over the past three months to the lowest since mid-2020.

Prior to this, the "mini non-farm" ADP private sector employment and JOLTS job vacancy numbers released this week had both fallen to three-and-a-half-year lows, with Challenger layoff statistics even worse, continuing to shake the market and dampen sentiment about the economy. Adding another weak labor data point will only deepen people's concerns about the health of the US economy, enough to trigger panic selling in the stock market.

Therefore, despite the August unemployment rate falling slightly to 4.2% as expected, breaking a four-month streak of increases, and the year-on-year wage growth of 3.8% moving away from a two-year low, which are considered "good news", **market participants are more focused on the negative side of the data For example, the U6 unemployment rate, which reflects "underemployment," rose to 7.9%, the highest since October 2021; the growth pillars of employment in August, the education and healthcare sectors, saw the smallest increase since 2022; the employment participation rate of prime-age workers aged 25 to 54 declined for the first time since March; over the past three months, the average increase in private sector employment was 96,000, falling below 100,000 for the first time since the outbreak of the COVID-19 pandemic, and so on.

Betsey Stevenson, former Chief Economist at the U.S. Department of Labor, said in a media interview, "Currently, non-farm employment growth in the United States is actually only coming from three sectors: leisure and hospitality, healthcare and education services, and government. We have not seen much growth in business and professional services, which I think indicates that the economy is slowing down."

Some analysts believe that the market is entering a new paradigm, shifting its focus from inflation to growth, and negative economic news is now unfavorable for the stock market.

Other analysts believe that the reason behind the tense market on Friday is that stocks and bonds are far more sensitive to economic indicators than in the past—because investors know how important the prospect of a "soft landing" is for the U.S. economy, market sentiment fluctuates so dramatically, with any slight change in economic data being magnified into concerns about recession or a rapid rebound in the stock market after temporary relief.

The above analysis suggests that we are entering a new market paradigm, with two major themes emerging: a shift in focus to economic growth rather than inflation, and with expectations of the Fed cutting rates, previously unpopular stocks are outperforming market stars.

As Johanna Kyrklund, Chief Investment Officer at Schroders, said, six months ago the risk of a U.S. economic recession was zero, but now the risk is that the weakness of low-income households is beginning to affect the entire economy. Even if the Fed starts cutting rates, the market will remain highly sensitive to signs of economic weakness, as the risk of recession is expected to persist for quite some time:

Concerns about economic weakness are also reflected in the changing relationship between stocks and bonds. When the market focuses on inflation, good economic news is usually bad news for the stock market because it implies pressure from rising prices and Fed rate hikes.

Now, good economic news is favorable for the stock market as it alleviates concerns about economic growth and is expected to cut rates anyway. Conversely, bad economic news is now unfavorable for the stock market.

Therefore, the one-year relationship between the S&P 500 Index and the 10-year Treasury yield has now reversed. Stocks and bond yields are vaguely showing a trend of rising and falling together, rather than moving in opposite directions as before.

The "New Fed News Agency" stated that the non-farm payroll data cannot indicate the extent of the rate cut in September, and Fed policymakers have not clearly signaled a significant rate cut.

Furthermore, the second reason for the sharp decline in U.S. stocks on Friday may lie in the latest non-farm employment data and subsequent speeches by several Fed officials, which still do not provide a clear indication of the specific extent of the Fed's rate cut in September, only ensuring that "a rate cut will definitely occur, clearing the way for the rate cut." Even the well-known financial journalist Nick Timiraos, who is hailed as the "new Fed communication agency," said that the non-farm report is uncertain, and whether the Fed will cut interest rates by 25 or 50 basis points in September is still unknown:

"Overall, the non-farm data has not deteriorated enough to change the market's benchmark expectations to a 50 basis point rate cut, but considering the revised data, it is not convincing enough to completely dispel speculation of a larger rate cut. In recent weeks, the biggest question is whether the summer impact reflected in the data is temporary (perhaps Hurricane Berel suppressed hiring activity) or evidence of an overall economic slowdown. (All we can say is,) summer hiring has slowed down, and a Fed rate cut is inevitable."

Looking at the comments of several Fed voters after the non-farm employment report, they did indicate that a rate cut in September is certain, but their affirmations of the health of the economy and the mention of "cautiousness" seem to contradict the market's betting on a 50 basis point rate cut after the non-farm report. The "three big shots" of the Fed, New York Fed President Williams, hinted at starting with a traditional 25 basis point rate cut.

Many analysts have found that Williams, a staunch ally of Powell, emphasized that the U.S. economy remains fundamentally solid, with the unemployment rate likely to stabilize around 4.25% this year, showing no sense of urgency for a larger rate cut.

Even Fed Governor Waller, who mentioned "advocating front-loading rate cuts if appropriate," did not open up about a significant 50 basis point rate cut in September, but instead stated that the economy is "performing well," the outlook for continued growth is "good," the labor market "continues to be weak but not deteriorating," and he expects rate cuts to be "cautious."

Traders' bets on the size of the rate cut in September are wavering, and Wall Street is engaged in intense debates, which may leave the stock market directionless

The so-called "front-loading rate cuts" refer to aggressively cutting rates first on the basis of anticipating economic deterioration, such as starting with a large rate cut in the early stages of easing, stabilizing the economy, and then switching to more traditional 25 basis point rate cuts.

After the non-farm employment report, the market did indeed increase its overall bet on the size of the Fed rate cuts this year, but the uncertainty between whether it will be a 25 or 50 basis point cut in September remains, ultimately the more traditional pace of rate hikes prevailed over the more aggressive expectations. However, the market believes that there may be a 50 basis point rate cut in November, with about 4.5 "25 basis point rate cuts" before the end of the year.

Some analysts have pointed out that many investors originally thought that the August non-farm report would indicate the magnitude of this month's rate cut, but the data turned out to be neither good nor bad, showing a significant slowdown in job growth but almost no change in the unemployment rate. This has left traders currently in a state of uncertainty, unable to provide support for the stock market, and may even be subtly disappointed that a 50 basis point rate cut may not happen.

Scott Wren of Wells Fargo Investment Research Institute said that the financial markets have shifted their focus to how much policy easing the Fed will do and the speed of economic slowdown, expecting short-term volatility to continue.

Chris Larkin of Morgan Stanley's E*Trade division also stated that the U.S. August non-farm employment figures fell short of expectations, which may boost investors' expectations for a 50 basis point rate cut by the Fed in September, but there is still some time before the FOMC policy meeting, and there may still be no definitive conclusion at present The current basic assumption is still that the cautious Federal Reserve will cut interest rates by 25 basis points in September, and the market may remain sensitive to "subsequent data indicating excessive cooling of the U.S. economy."

Wall Street is fiercely debating whether the August non-farm payroll and recent soft data can effectively support the Federal Reserve's decision to cut interest rates by 50 basis points in September.

Sammy, the former Treasury Secretary and a whistle-blower for high U.S. inflation, stated that the soft non-farm payroll data brings the Federal Reserve closer to cutting interest rates by 50 basis points in September. However, David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, does not support initiating a looser monetary policy cycle with a larger rate cut:

"I strongly believe that the initial rate cut should only be 25 basis points. If the Federal Reserve cuts rates by 50 basis points, it will make everyone feel uneasy about the extent of economic deterioration... For psychological reasons, I think it would be much better for them to gradually cut rates."

Torsten Slok, Chief Economist at Apollo Global Management, believes that the market's expectation of a 50 basis point rate cut in September is excessive, reflecting an excessive concern about economic recession. The August non-farm payroll report indicates that signs of recession are not obvious, "the unemployment rate is declining, there is no need for a significant 50 basis point rate cut."

Seema Shah, Chief Global Strategist at Principal Asset Management, stated that for the Federal Reserve, the key decision is to determine which risk is greater: whether a 50 basis point rate cut will reignite inflationary pressures, or a 25 basis point rate cut will bring recession risks. However, "overall, in a situation of subdued inflationary pressures, the Federal Reserve has no reason not to act cautiously and pre-emptively (with a significant) rate cut."

"Recession advocates" gaining ground, reinforcing the classic stock market softness in autumn, U.S. bond yield curve ending inversion may imply recession

As for other reasons for the sharp decline in U.S. stocks on Friday or this week, some media opinion articles point out that in September, the bears seem eager to take the lead before the yet-to-appear economic recession, despite multiple data still supporting the soft landing narrative. However, the voices of "recession advocates" are currently louder and dominating the discourse, which may exacerbate the "classic stock market softness trend" in September and October over the past four years.

The pessimists argue that on one hand, Goldman Sachs claims that September is not only the weakest performing month of the year, but the second half of September is usually the worst two-week trading period for the S&P 500 index. At the same time, the unusually strong momentum of corporate stock buybacks this year may soon slow down, as companies will enter a silent period of buybacks for several weeks before the next earnings release, "lack of liquidity" will drag down the stock market.

Furthermore, U.S. stock indices, especially the darling of capital in the past year, popular tech stocks, still have relatively high valuations, "the biggest problem is that market prices are still expensive." This week's price decline has not had a significant impact on overall valuations, and the "painful trading" that makes everyone uncomfortable will lead to further market declines, "this is the natural result of high valuations and economic slowdown."

It is worth noting that on Friday, the two-year U.S. Treasury yield has been consistently lower than the 10-year benchmark bond yield, indicating the crucial yield curve ending inversion Wall Street News has mentioned that according to Dow Jones market data, since July 1, 2022, there has not been a long-term situation where the long-term U.S. bond yield is higher than the short-term bond yield at the close of trading. Once this occurs, it will end the longest period of yield curve inversion on record. As of this Thursday, the curve has been inverted for 545 consecutive trading days.

Analysis has also pointed out that weak labor data has fueled bets on a Fed rate cut, temporarily ending the yield curve inversion. However, historically, the end of the yield curve inversion has signaled economic troubles ahead, which may not be entirely positive for the stock market:

"Many analysts have pointed out that although the end of a long-term yield curve inversion usually occurs when the Fed begins cutting rates, as the Fed often eases policy only when the economy is facing difficulties, the end of the yield curve inversion may actually heighten investors' concerns about an economic recession, which is a negative signal for the stock market as well."