Why Stocks Rallied On A Solid Jobs Report

U.S. equities shook off another rise in Treasury bond yields fueled by a solid labor market report released on Friday to stage a board rally. It's a relief for Wall Street bulls who have been hiding in recent weeks.

The U.S. nonfarm payrolls jumped by 336,000 in September 2023, up from 227,000 in August and well above market expectations of 170,000.

That's the most substantial job gain in recent months, thanks to solid hiring in leisure and hospitality (96,000), government (73,000), health care (41,000) and professional, scientific and technical services (29,000).

A solid jobs report is usually unfavorable for equities, as it raises fears of further interest rate hikes to ease inflation pressures. Thus, the spike in the U.S Treasury bond yields sent stocks sharply lower in pre-market and early regular trading on Friday.

But the situation changed by early afternoon, with Treasury bond yields leveling off and equities reversing course. At the close, the S&P 500 was up 1.18%, the Dow Jones 0.87% and the tech-heavy NASDAQ 1.60%.

The leveling of Treasury bond yields and the sharp turnaround in equities following a robust jobs report may have surprised macroeconomists and portfolio strategists.

Michelle Cluver, portfolio strategist at Global X ETFs, is one of them. " The U.S. labor markets remain extremely tight, with September's nonfarm payrolls surging past expectations," she told International Business Times.

Cluver observed that 336,000 September job gains reflect a monthly increase well above the 267,000 monthly run rates over the prior 12 months.

"Unfortunately for markets, this reading reflects there could be more the Fed needs to do to contain inflation pressures," she added. "Long-dated yields continued their march higher as this reading reiterated the message of yields potentially needing to remain higher for longer. While encouraging for the resilience of the U.S. economy, this extreme reading is a challenge for markets."

Still, there are a couple of good explanations for Wall Street's sharp turnaround in the face of solid job gains.

First, the unemployment rate, another gauge of labor market conditions, remained steady in September, meaning the labor market isn't getting tighter. And that can explain the moderate 0.2% increase in hourly earnings, in line with August gains and below market forecasts of a 0.3% gain.

The moderate hourly earnings gains eased Wall Street's fears of a wage-price spiral, which could elevate inflation, forcing the Fed to keep raising interest rates.

Second, bond and equity markets have been selling off for several weeks in anticipation of a resilient economy and higher interest rates. Thus, market participants may have fully discounted the news of a strong jobs report, treating it like old news.

Third, the rise of interest rates has already been doing the Fed's job, tightening liquidity at the long end of the yield curve. In addition, the Fed cannot keep interest rates high for too long in the face of soaring government deficits.

"Today's blowout number and upward revisions are painful on the surface," David Russell, global head of market strategy at TradeStation. "They push Fed rate cuts even further into the future and keep the 10-year Treasury yield rising. Jerome Powell still has a blank check to crush inflation without worrying about a recession. "

But he sees a silver lining beneath the surface: the moderation in wage growth and the steadying of unemployment. "That shows people keep coming back to work without driving up pay. Goldilocks is possible over the longer term, but things are still too hot for the bulls to run," Russell added.

Still, Steve Wyett, chief investment strategist at BOK Financial, sees a mixed picture ahead for equities, caught between the prospect of better earnings and higher interest rates.

"All of this will provide the Fed with the idea that stability and higher for longer is the recipe for monetary policy," he told IBT. "Bond markets reflect an outlook for better growth as rates move higher, and equities are digesting an environment where earnings might be better, but higher rates are a headwind to valuation."