On Friday, September 6th, as U.S. Treasury yields continued to decline "as expected" due to poor August U.S. non-farm employment data, the U.S. stock market once again demonstrated its "elusive" nature. It opened higher due to increased expectations for interest rate cuts, only to plummet sharply soon after.

After the midday session, major U.S. stock indices continued to hit new daily lows, with technology and chip stocks closely linked to the AI trend leading the decline. The S&P 500 index fell nearly 100 points or 1.8%, the Dow Jones Industrial Average, a collection of blue-chip stocks, fell over 430 points or 1%, and the tech-heavy Nasdaq Composite fell 450 points or 2.6%. The Russell 2000 small-cap index, highly sensitive to the economic cycle, fell 2%, and the "fear index" VIX rose by more than 17%.

This week, the U.S. released several disappointing economic data reports, indicating a continued cooling of the labor market, as well as data showing a manufacturing sector still mired in contraction and a service sector that is "only" modestly expanding. This led investors to sell risk assets and buy safe-haven U.S. Treasuries amid heightened growth concerns. The S&P 500 index fell more than 4% for the week, the Dow Jones Industrial Average fell nearly 3%, heading for the worst half-year since March 2023, the Nasdaq Composite fell nearly 6%, and U.S. Treasury yields hit new lows for over a year.

Advertisement

Currently, all major U.S. stock indices are at their lowest levels since mid-August, and both the S&P 500 and the Russell 2000 small-cap index have fallen for four consecutive days this week, meaning that since the long weekend on Tuesday, the first trading week of September has seen declines every day.

The consensus analysis is that the latest non-farm employment report raises many doubts, and concerns about AI demand also hit the technology sector, causing the stock market to deteriorate further on Friday. The August non-farm employment increase was below expectations, and the data for the previous two months were revised downward, causing the market, already shaken by recent stock market turmoil, to be like a frightened bird, amplifying any flaws.

The market focused on the "bad" aspects of the August non-farm employment, intensifying concerns about economic slowdown and suppressing risk appetite. The main reason for the decline in U.S. stocks and the rise in bonds on Friday was the poor August non-farm employment data in the United States. Although this data can be considered "mixed" overall, it did not send a completely pessimistic signal, but it did reveal a trend of the labor market cooling faster than expected, intensifying concerns about economic slowdown and, in turn, suppressing investors' risk sentiment.

Specifically, while the 142,000 new jobs added in August are in line with the average employment growth rate in recent months, they represent a significant slowdown compared to the average increase of over 200,000 people in the past 12 months. Moreover, the combined revision of June and July data downward by 86,000 not only creates a tense atmosphere where the labor market loses momentum earlier than expected but also brings the average new employment for the past three months to its lowest since mid-2020.

Prior to this, the "small non-farm" ADP private sector employment and JOLTS job openings released earlier this week had both dropped to their lowest levels in three and a half years, and the Challenger layoff statistics were even worse, with ongoing economic concerns shaking the market and suppressing sentiment. Adding another weak labor force data only deepens people's concerns about the health of the U.S. economy, enough to trigger panic selling in the stock market.

Therefore, although the August non-farm unemployment rate fell slightly to 4.2% as expected, breaking the trend of four consecutive months of increases, and the year-on-year wage growth of 3.8% moved away from the previous value's low point of over two years, which are both "good news," market participants are more focused on the negative side of the data.For instance, the U6 unemployment rate, which reflects "underemployment," has risen to 7.9%, the highest since October 2021; the increase in employment in education and healthcare, the mainstay of job growth in August, is the smallest since 2022; the employment participation rate of prime-age workers aged 25 to 54 has declined for the first time since March; and the average monthly increase in private sector employment over the past three months is 96,000, the first time it has fallen below 100,000 since the outbreak of the COVID-19 pandemic.

Betsey Stevenson, former Chief Economist at the U.S. Department of Labor, stated 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 are not seeing much growth in business and professional services, and I believe this indicates that the economy is slowing down."

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

Another analysis points out that the reason behind the market's tension on Friday is that stocks and bonds are far more sensitive to economic indicators than in the past—because investors understand how significant the prospect of a "soft landing" is for the U.S. economy, hence the market sentiment is so volatile. Any minor change in economic data can be magnified into concerns about a recession, or a rapid rebound in the stock market after temporary relief from these concerns.

The aforementioned analysis believes that this indicates we are entering a new market paradigm, where two major themes emerge: the focus shifts to economic growth rather than inflation, and, driven by expectations of an upcoming interest rate cut by the Federal Reserve, previously unpopular stocks outperform market favorites.

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 in low-income households begins to affect the entire economic sector. And even if the Federal Reserve starts to cut interest rates, the market will remain highly sensitive to signs of economic weakness, as the risk of recession will persist for a considerable period:

The concern for economic weakness is also reflected in the changing relationship between stocks and bonds. When the market focuses on inflation, good economic news is usually bad for the stock market because it implies pressure for rising prices and interest rate hikes by the Federal Reserve.

Now, good economic news is favorable for the stock market because it alleviates concerns about economic growth, and interest rate cuts are expected anyway. The reverse is also true: bad economic news is now unfavorable for the stock market.

As a result, the one-year correlation between the S&P 500 index and the 10-year U.S. Treasury yield has now reversed. Stocks and bond yields are subtly showing a trend of moving in the same direction, rather than moving in opposite directions as before.

The "new Fed mouthpiece" says that the non-farm payrolls do not indicate the magnitude of the interest rate cut in September, and Federal Reserve members have not clearly indicated a significant rate cut.Additionally, the second reason for the significant drop in the U.S. stock market on Friday likely lies in the latest non-farm employment data and the subsequent speeches by several Federal Reserve officials, which still fail to clarify the specific magnitude of the Federal Reserve's interest rate cut in September. It only ensures that "a rate cut will definitely happen, paving the way for it."

Even the renowned financial journalist Nick Timiraos, dubbed the "new Fed whisperer," stated that the non-farm report is unclear, and whether the Federal Reserve will cut rates by 25 or 50 basis points in September remains unknown: "The overall non-farm data is not bad enough to shift the market's base case to a 50 basis point rate cut, but considering the revised data, it is not convincing enough to completely dispel speculations about a more significant rate cut.

The biggest question in recent weeks has been whether the data reflects a temporary summer shock (perhaps Hurricane Barry suppressing hiring activities) or evidence of an overall economic slowdown.

(One can only say that) the slowdown in hiring activities this summer makes a rate cut by the Federal Reserve inevitable."

Looking at the remarks of several Federal Reserve policymakers after the release of the non-farm employment data, they indeed only revealed that a rate cut in September is certain, but their affirmation of the health of the economy and the "caution" mentioned by many seem to be at odds with the market's increased bets on a 50 basis point rate cut after the non-farm data, as the Federal Reserve's "third in command," New York Fed President Williams, hinted that rate cuts would start from the traditional 25 basis points.

Many analyses 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 urgency for a more significant rate cut.

Even the Federal Reserve Governor Waller, who mentioned "advocating for front-loaded rate cuts if appropriate," did not loosen his stance on a significant 50 basis point rate cut in September, but stated that the economy is "performing solidly," the outlook for continued growth is "good," the labor market "continues to be weak but not deteriorating," and expects rate cuts to be "cautiously conducted."

Traders' bets on the scale of the rate cut in September are wavering, and Wall Street is also engaged in fierce debates, which may leave the stock market lacking direction.

The so-called "front-loaded rate cut" refers to the preemptive and aggressive rate cut at the beginning, based on the anticipation of a worsening economic situation, such as cutting rates significantly at the start to stabilize the economy before switching to a more traditional 25 basis point rate cut each time.Following the release of the non-farm employment figures, the market did indeed increase its overall bets on the extent of the Federal Reserve's rate cuts for this year, but it remains indecisive and divided on whether there will be a 25 or 50 basis point cut in September. Ultimately, the more traditional pace of rate hikes prevailed over the more aggressive expectations. However, the market believes that there might be a 50 basis point rate cut in November, with approximately 4.5 "25 basis point cuts" by the end of the year.

Analysts have said that many investors originally thought that the August non-farm employment figures would indicate the magnitude of the rate cut this month. 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, leaving traders in a state of uncertainty and thus unable to provide support for the stock market. Instead, there might be a subtle disappointment that a 50 basis point rate cut is not possible.

Scott Wren from Wells Fargo Investment Institute stated that financial markets have shifted their focus to how much policy easing the Federal Reserve will implement and the pace of economic slowdown, expecting continued short-term volatility.

Chris Larkin from Morgan Stanley E*Trade also mentioned that the underwhelming August non-farm employment figures in the United States might boost investors' expectations for a 50 basis point rate cut by the Federal Reserve in September. However, there is still some time before the FOMC policy meeting, and there may not be a conclusion yet. The current basic assumption is that the more cautious Federal Reserve will cut rates by 25 basis points in September, and the market may remain sensitive to "subsequent data indicating that the U.S. economy is cooling down excessively."

Wall Street is engaged in a fierce debate on whether the August non-farm employment figures and recent weak data can effectively support the Federal Reserve's decision to cut rates by 50 basis points in September.

Former Treasury Secretary and U.S. high inflation whistleblower Summers said that the weak non-farm employment figures bring the Federal Reserve closer to a 50 basis point rate cut in September. However, David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, does not agree with initiating a monetary policy easing cycle with a more significant rate cut:

"I strongly believe that the first rate cut should only be by 25 basis points. If the Federal Reserve cuts rates by 50 basis points, it would make everyone (worry about the degree of economic deterioration)... For psychological reasons, I think it's much better for them to cut rates gradually."

Torsten Slok, Chief Economist at Apollo Global Management, believes that the market's reaction to a 50 basis point rate cut in September is overblown, reflecting excessive concerns about an economic recession, while the August non-farm report shows that signs of recession are not apparent, "The unemployment rate is falling, there is no need for a significant 50 basis point rate cut."

Seema Shah, Chief Global Strategist at Principal Asset Management, said that for the Federal Reserve, the key to decision-making is to determine which risk is greater: whether a 50 basis point rate cut would reignite inflationary pressures, or whether a 25 basis point rate cut would bring recession risks, but "overall, in the context of low inflationary pressures, there is no reason for the Federal Reserve not to act cautiously and front-load (significant) rate cuts."

"Recessionists" are gaining the upper hand, reinforcing the classic stock market weakness in the fall, and the end of the U.S. Treasury yield curve inversion may suggest a recession.As for the other reasons behind the significant drop in the U.S. stock market on Friday or this week, media opinion articles have pointed out that in September, short sellers seem eager to get ahead of an economic recession that has not yet materialized. Although various data still support the notion of a soft landing, the voices of "recessionists" are currently louder and dominate the discourse, which could exacerbate the "classic stock market weakness" in September and October over the past four years.

The bears argue that, on one hand, Goldman Sachs has stated that September is not only the weakest-performing month of the year but also that the second half of September is typically the two-week trading period with the worst performance for the S&P 500 within the year. At the same time, the unusually strong momentum of corporate stock buybacks this year may soon slow down, as companies will enter a several-week buyback quiet period before the release of their next earnings report. The "lack of fresh water" could drag down the stock market.

Furthermore, the valuations of U.S. stock indices, especially the capital favorites and hot tech stocks of the past year, remain high. "The biggest problem is that market prices are still expensive," and this week's price drop did not have a significant impact on overall valuations. The "painful trade" that makes everyone uncomfortable could lead to further market declines. "This is the natural result of high valuations and economic slowdowns."

It is worth noting that on Friday, the two-year U.S. Treasury yield has been below the 10-year benchmark yield, i.e., the key yield curve ended its inversion.

Wall Street Journal has mentioned that Dow Jones market data shows that since July 1, 2022, there has not been a case where long-term U.S. Treasury yields have closed above short-term yields. If 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.

Analysts have also pointed out that weak labor data has fueled bets on Fed rate cuts, causing the U.S. Treasury yield curve to briefly end its inversion. However, historically, when the yield curve ends its inversion, the economy begins to face problems, which may not be entirely positive for the stock market:

"There is considerable analysis suggesting that although the end of a long-term inversion of the U.S. Treasury yield curve typically occurs when the Fed starts to cut rates, since the Fed often eases policy when the economy encounters difficulties, the end of the yield curve inversion could actually intensify investors' concerns about an economic recession, which is also a negative signal for the stock market."