Investors won on Friday, as fresh data about the health of the labor market paved the way for the Federal Reserve to deliver another bumper increase to interest rates next month, raising costs for companies and weighing on stock prices.
The S&P 500 fell nearly 3 percent on Friday, dragged down by interest rate-sensitive sectors like technology stocks. Government bond yields, indicative of the future path of interest rates, rose and the dollar strengthened.
American employers added 263,000 jobs in September, down from 315,000 in August, the Labor Department said early Friday. While the slight slowdown in hiring offered another signal that the Fed’s efforts to cool the economy and reduce inflation were having an effect, it was balanced against a drop in the unemployment rate to 3.5 percent from 3.7 percent, reinforcing a sense that the labor market remains sturdy.
Typically a sign of economic strength, at the moment a resilient labor market is bad news for investors, as it points to the need for the Fed to raise interest rates even more than it already has. Higher rates, in turn, raise costs for companies, weighing on stock prices.
“At this point, the market is looking for any reason for the Fed to blink,” said Ian Lyngen, an interest rate strategist at BMO Capital Markets. “This report didn’t give it to us.”
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Policymakers had already dampened any expectation of an immediate policy shift in the run-up to Friday’s data release, cautioning against market expectations that the Fed’s fight against inflation was nearly over. For investors, the fresh numbers confirmed what they had already been told.
Market expectations of how much the Fed will raise interest rates when officials meet in November nudged upward, predicting another three-quarter-point increase. Such an increase was seen as unusually large not long ago, but if the Fed raises rates by that much in November it would be the fourth time this year that it’s done so.
“I would say this is what the Fed is going to do,” Andrew Brenner, the head of international fixed income at National Alliance Securities, said of forecasts for another aggressive Fed rate increase. He added that it would take a significant slowdown in consumer prices when the latest data is released next week to alter policymakers’ path. “I don’t see anything to determine them at this point.”
The Fed has already raised interest rates rapidly this year, alongside other central banks around the world. They are all fighting high inflation, stemming from the reopening of economies after the start of the pandemic, and amplified by soaring energy prices after Russia’s invasion of Ukraine.
The consensus among investors is for interest rates to rise another 1.25 percentage points before the end of the year, reaching a peak around 4.6 percent next year, in line with Fed policymakers’ forecasts. But investors continue to bet that an economic slowdown, alongside falling inflation, could prompt the central bank to begin lowering rates before the end of 2023, sooner than Fed officials have said is likely.
The concern is that a more sustained period of higher interest rates could destabilize the financial system, leading to the kinds of whipsaw price movements that sent shock waves through British government bond markets last month.
The Fed “would like to slow down,” said Ellen Zentner, the chief US economist at Morgan Stanley. “It’s dangerous when you go at this speed for too long. But I think this report is another piece of evidence that they are going to deliver another outsized hike in November.”
Investors will be watching for clearer signs on how higher interest rates are affecting corporate profits as quarterly earnings reports for the third quarter ramp up next week.
Despite Friday’s drop, a rally on Monday and Tuesday left the S&P 500 on course for a gain of around 1.5 percent for the week, after three straight weeks of losses. The index remains more than 20 percent lower for the year.
Elsewhere on Friday, Europe’s Stoxx 600 index slumped 1.2 percent, Japan’s Topix dipped 0.8 percent and China’s CSI 300 fell 0.6 percent.