According to the data from Bank of America, the biggest risk for the stock market this week is the August non-farm payroll report exceeding expectations.

In a report on September 2nd, Bank of America analysts stated that the non-farm payroll report has become the most important data for the stock market. Futures contracts for the S&P 500 index are more sensitive to employment reports than inflation data.

Since August 2019, the reaction of eMini S&P 500 futures contracts to non-farm and CPI data has been observed from 5 minutes before the data release to 30 minutes after the release.

As inflation has significantly declined from its peak in 2022, investors are now closely watching the labor market for signs of weakness. Bank of America emphasizes in its report that an overheated job market could lead to a repricing of expected rate cuts this year.

Bank of America strategist Ohsung Kwon stated, "Based on the market's performance returning to high levels, as well as the performance of small cap stocks and the equal-weighted S&P 500 index, the market seems more excited about the Fed's rate cuts this year rather than concerned about a potential economic recession."

He added, "If this is true, then the main risk for the stock market this week is higher-than-expected non-farm payroll data, which would lead to a reevaluation of short-term interest rate pricing (i.e., reducing rate cut expectations)."

The August non-farm payroll report will be released on Friday morning. Economists expect the US economy to have created 0.162 million jobs last month, which if accurate, would bring the unemployment rate down from 4.3% to 4.2%.

According to CME's FedWatch tool, economists at the Bank of America expect the Fed to cut interest rates only twice this year, each time by 25 basis points, while the market expects a rate cut of up to 100 basis points within the year.

If the US non-farm payroll report shows a strong rebound from the soft trend in July, this could change market sentiment and prove that investors are overly confident in the Fed's interest rate cut path.

According to the Bank of America's report, this could bring downward pressure to the stock market. Kwon recommends that investors hedge the downside risk by using put spreads on the S&P 500 index expiring in October.

The latest signs of resilience in the US economy include the second-quarter GDP growth rate being revised up from 2.8% to 3%, as well as robust personal spending data, which increased by 0.5% month-on-month in July.

According to the Bank of America's report, the economy is still maintaining a robust momentum. Kwon said, "The economy is still proving the skeptics wrong. Compared to last year, the growth has certainly cooled down, but at a gradual pace."

Tuesday's data showed that US manufacturing activity remained weak in August, leading to a sharp decline in major stock indexes. In response, Thomas Ryan, North American economist at Capital Economics, stated in a report on the latest ISM manufacturing index, "Despite the soft survey data, our tracking based on hard data indicates that the US GDP will still maintain an annualized growth rate of 2.5% in the third quarter."

Ed Yardeni of Yardeni Research is also one of the Wall Street strategists expecting a strong jobs report to be released on Friday.

In a report to clients on Monday, Yardeni stated that he expects an addition of 0.2 million to 0.225 million jobs in August.

If this is true, it would break economists' estimates and be consistent with the strong employment reports in May and June, thus reinforcing the idea that the Federal Reserve does not need to cut interest rates significantly.

Yardeni said, "The Federal Reserve is unlikely to rapidly and substantially lower the federal funds rate as it did when the financial crisis triggered credit tightening and economic recession."

While Yardeni's optimistic outlook is good news for the economy, it could become a resistance to stock prices in the short term.

Editor/Rocky