Overview of U.S. and Global Markets

By Mike Dolan

U.S. stocks appear to have weathered the early September turmoil, but interest rate speculation and declining bond yields are now taking center stage amid evidence of a slowing U.S. labor market.

Futures markets indicate nearly a 50-50 chance of a 50 basis point Federal Reserve rate cut this month, with two-year Treasury yields reaching 3.75% on Thursday for the first time in 16 months.

The Treasury market seems to suggest that the Fed may be slow to respond to the weakening employment picture, as the gap between two-year yields and the Fed policy rate is at its widest since 1981.

After over two years of an inverted 2-to-10 year Treasury yield curve, this gap has closed to zero. Although traditional market signals about the current economic cycle have had mixed outcomes, historically, that yield curve measure has become positive just before a recession.

As a week of significant labor market updates unfolds, the reasons for increased easing speculation are evident. Following a dismal report on declining manufacturing activity on Tuesday, Wednesday’s data revealed that U.S. job openings dropped to a 3-1/2-year low in July.

Despite these numbers being from the month prior to this week’s crucial August employment report, the Fed’s latest ‘Beige Book’ economic update characterized the job market as “generally flat to up slightly in recent weeks,” heightening the stakes. The ratio of job openings to job seekers has nearly returned to pre-pandemic levels.

Private sector job data and updates on layoffs for August, as well as weekly jobless claims numbers, are all set to be released later on Thursday. The Fed is closely monitoring these figures. San Francisco Fed President Mary Daly stated that the Fed needs to cut rates to maintain a healthy labor market, warning, “As inflation falls, we’ve got a real rate of interest that’s rising into a slowing economy; that’s a basic recipe for over-tightening.”

Atlanta Fed President Raphael Bostic remarked that he is now giving equal attention to the Fed’s maximum employment mandate as he is to inflation, stressing, “We must not maintain a restrictive policy stance for too long.”

These developments may understandably unsettle the stock market. However, the Atlanta Fed’s real-time GDPNow growth model shows the economy is still growing at over 2% in the current quarter. Service sector surveys for August, releasing later on Thursday, are likely to provide a clearer view of activity compared to the earlier factory data.

Challenging easing speculation and bolstering the bond market rally, oil prices continue to struggle. U.S. crude prices remain below $70 per barrel, exhibiting year-on-year declines of almost 20% for the first time in a year.

The Bank of Canada confidently cut its policy rates for the third time this year, as expected, with Governor Tiff Macklem suggesting that a more significant cut could be warranted if the economy requires support.

As the week progresses with additional significant reports, Wall Street stock indexes stabilized on Wednesday after the early-week selloff, with futures slightly negative before today’s opening and global stocks also inching lower. The VIX volatility gauge has settled around 20—just above historical averages.

The dollar index was also lower but received a slight uplift from optimistic German industry orders data for July, which somewhat alleviated the manufacturing gloom.

However, the Ifo institute in Germany indicated that the economy is likely to stagnate this year, revising its previous 0.4% growth forecast downward.

Key Developments to Watch for U.S. Markets Later Thursday:

• August private sector payrolls from ADP,
• Weekly jobless claims,
• August layoffs,
• August service sector surveys from ISM and S&P Global,
• Q2 revisions of productivity and unit labor costs,
• U.S. corporate earnings announcements from Broadcom, DocuSign, Smith & Wesson, American Outdoor Brands, etc.,
• U.S. Treasury selling $85 billion of 4-week bills.

(By Mike Dolan, editing by Ros Russell; mike.dolan@thomsonreuters.com)