Stocks and bonds rallied on Friday as new data about the health of the US labor market provided relief for investors who experienced a tumultuous week. The 10-year government bond yield, which impacts rates on mortgages and business loans, dropped 0.1 percentage points on Friday in a significant decline for a market known for its minimal daily fluctuations. Yields move inversely to prices.
The latest report revealed that the US economy added fewer jobs than expected in October, indicating a cooling labor market that could reduce the need for the Federal Reserve to raise interest rates to fight inflation and slow the economy. This positive news helped boost the stock market, which had experienced declines due to rising rates in recent months. The S&P 500 closed the week nearly 6 percent higher, marking its best performance of the year.
While the Federal Reserve had been increasing its critical short-term rate since March of the previous year, investors had focused on longer-term market rates, which are influenced by various factors such as economic growth and inflation expectations, not solely by the Fed’s policy decisions. These long-term rates began surging in August, leading to concerns about the sustainability of the US government’s massive debt pile, among other worries. However, some of these concerns eased this week.
Investors found solace in the Treasury Department’s plans to shift its borrowing towards shorter-term debt, alleviating pressure on longer-dated yields. Additionally, Fed Chair Jerome H. Powell’s announcement that the central bank would keep rates steady for the second consecutive meeting helped calm investors. The weaker-than-expected job growth further suggested that the Fed’s efforts to slow the economy were proving effective.
Stocks and Bonds Rally Amidst Labor Market Relief and Yield Plunge
The 10-year Treasury yield plummeted 0.3 percentage points for the week, reaching just below 4.6 percent, which marked its most substantial drop since the banking turmoil in March. However, the yield remains more than half a percentage point higher than at the beginning of August. The decline in profits sparked a broad rally across stock markets, with the Russell 2000 index of smaller companies rising 2.8 percent on Friday. The index had previously fallen over 18 percent but rallied approximately 8 percent this week, its most significant weekly surge since the early stages of pandemic recovery in 2020.
Nevertheless, some investors cautioned against viewing the market reaction through an overly optimistic lens. Despite the slight increase in the unemployment rate to 3.9 percent in October, up from 3.8 percent the previous month, and a dip in the number of people actively seeking employment, the overall slowdown in work appeared manageable. Blerina Uruci, Chief U.S. Economist at T. Rowe Price, expressed concerns about increasing unemployment rates.
After releasing the jobs report, investors reassessed the likelihood of the Fed raising interest rates at its upcoming December meeting. They brought forward expectations of rate cuts in the coming year. This shift indicated the market’s belief that the Fed had concluded its rate hikes and that the economy would continue decelerating.
If the bond market’s recent reversal continues and yields continue to fall, it could ironically lead to the Fed raising the rate in December. This would be due to lower borrowing costs and an easing of the brakes on the economy. Mark Dowding, Chief Investment Officer at BlueBay, highlighted the two opposing forces currently at play. While a slowing economy is expected to lower longer-term rates, concerns about who will purchase the considerable debt the U.S. government is set to issue could push rates in the opposite direction.
Paul Christopher, Head of Global Investment Strategy at the Wells Fargo Investment Institute, acknowledged this cross-current situation, saying, “One is the slowing economy, which is entrenched now and that will bring yields down. But over time, the Treasury will issue more debt, and those yields will go back up again. We are in a cross-current right now.”