What happened?
The S&P 500 fell 2.8% on Friday, paring its weekly gains to 1.5%, after the US nonfarm payrolls report showed the US labor market remains tight, supporting the case for the Federal Reserve to continue tightening policy aggressively. The US economy added a net 263,000 new jobs in September, and the unemployment rate fell back to 3.5%, matching the pre-pandemic level at a 50-year low.
Ten-year Treasury yields rose 6 bps to 3.88% and closed the week 8bps higher. The Dollar Index (DXY) strengthened 0.4% on Friday. Meanwhile, Brent crude oil prices continued to advance, rising 4.3% to USD 98.6/bbl, after OPEC+ announced earlier in the week that it would cut crude production by an effective 1–1.1 million barrels per day as of November.
What do we expect?
Friday’s fall in the S&P 500 capped a volatile week in which markets were driven by the waxing and waning of investor optimism about an earlier-than-expected pivot in Fed policy.
At the start of the week, US equities rallied 5.7% in two days and 10-year Treasury yields fell 24 bps as a weak ISM manufacturing reading for September and a fall of more than 1mn in JOLTS job openings in August offered evidence of a slowing economy and loosening labor market. This raised hopes that the Fed could soon shift away from its hawkish stance.
However, Fed officials were quick to push back against this view. Chicago Fed President Charles Evans said on Thursday that the benchmark rate will probably be at 4.5% to 4.75% by next spring, while the Minneapolis Fed’s Neel Kashkari said the central bank is “quite a ways away” from pausing its campaign of rate increases. Further data releases pointed to continued robust activity, underlining the case for tighter policy: The ISM non-manufacturing PMI edged lower to 56.7 in September from 56.9 in August, ahead of expectations for a reading of 56.
Overall, Friday’s nonfarm payrolls report reinforced the perception of continued strength in the labor market. There were some early signs of cooling in the data. The net rate of job creation at 263,000 for the month represents the slowest pace of jobs growth since April 2021. In addition, average hourly earnings showed a modest gain of 10 cents per hour in September after 9 cents in August. If sustained, this pace of wage growth would be compatible with the Fed’s 2% inflation target, in our view.
But the decline in the unemployment rate to 3.5%, from 3.7%, suggests that the labor market remains tight. Moreover, the labor force participation rate, which had risen in the prior month, edged lower to 62.3%. While it is important not to read too much into one month’s data, this could indicate that the US is running short of people on the sidelines who can rejoin the labor market.
The debate within central banks about the right pace of rate hikes is likely to intensify over the next few months, and we expect this to drive more of the volatility that investors have dealt with over the past few months, with periodic rallies followed by pullbacks. We think a more sustained rally in equities would likely require indications of a clear downtrend in US inflation, along with signs of a cooling labor market, which could then allow the Fed to pause its rate hiking cycle.
We continue to expect another 75-basis-point rate hike from the Fed in November. The consumer price index for September, due on 13 October, will be the key data release of the coming week. The NFIB survey of small businesses will also provide further information on job openings and wage growth.
How do we invest?
With uncertainty set to remain high in the months ahead, we recommend building portfolios that can prove resilient across a range of potential scenarios. We tilt our preferences toward more defensive areas of each asset class, including consumer staples and healthcare stocks, and high-quality bonds. Our preferred currencies include the US dollar and Swiss franc, two traditional safe havens that are also exposed to convincing rate-hike cycles.
We also like global value stocks, the energy sector—which should be supported by higher oil prices in the quarters ahead—and the value-oriented UK market. The MSCI All Country World Value index has outperformed its growth equivalent by 12 percentage points in the first three quarters of the year, and with inflation still well above central banks’ targets, we expect this trend to continue.
With equities and bonds driven by expectations around inflation and central bank policy, we also recommend that investors seek uncorrelated sources of return, for example through diversification into hedge funds, particularly discretionary macro strategies, and private markets.
