On Friday, September 6, as the US bond yields continued to decline due to the disappointing August US non-farm payrolls, the US stock market once again showed its" unpredictable "side. It opened high due to expectations of interest rate cuts, and then quickly dropped significantly.

At the close on Friday, major US stock indices fell sharply, with technology and chip stocks closely tied to the AI trend leading the decline. The S&P 500 index fell nearly 100 points or 1.73%, the Dow Jones Industrial Average, which gathers blue-chip stocks, fell more than 430 points or 1%, the Nasdaq, which is dominated by technology stocks, also fell 430 points or 2.55%, and the Russell 2000 small-cap index, which is highly sensitive to economic cycles, fell 1.91%, while the 'fear index' VIX rose more than 12%.

This week, the US released several disappointing economic data indicating a continued cooling of the labor market, as well as a manufacturing sector that remains in contraction and a service sector that is only mildly expanding. This has led investors to sell off risk assets and buy safe-haven US bonds in the face of growing growth concerns. The S&P 500 index fell more than 4% this week, the Dow Jones fell nearly 3%, reaching its worst level in a year and a half since March 2023, the Nasdaq fell nearly 6%, and US bond yields hit their lowest level in over a year.

Currently, major US stock indices are at their lowest levels in about four weeks since mid-August. The S&P 500 index and Russell small-cap index have both fallen for four consecutive days this week, meaning that every day since returning from the long weekend on Tuesday, the first trading week of September has seen declines. The latest non-farm payrolls report has raised concerns, and concerns about AI demand have also hit the technology industry, further worsening the stock market on Friday.

The market is focused on the 'poor' components of the August non-farm payrolls, which intensify concerns about economic slowdown and dampen risk appetite.

The main reason for the decline in US stocks and rise in bond prices on Friday was the poor performance of US non-farm payrolls in August. Although the overall data can be described as 'mixed', without completely pessimistic signals, it did confirm the trend of labor market cooling faster than expected, intensifying concerns about economic slowdown and thus dampening investor risk sentiment.

Specifically, although the addition of 0.142 million jobs in August is consistent with the average growth rate of the past few months, it is significantly slower compared to the average increase of over 0.2 million people in the past 12 months. Moreover, the previous values for June and July were revised down by a total of 0.086 million, creating a tense atmosphere of the labor market losing momentum earlier than expected, and bringing the average employment growth rate for the past three months to its lowest level since mid-2020.

Before that, the "small non-farm" ADP private sector employment and JOLTS job vacancy data released this week have both fallen to a three-and-a-half-year low. Challenger's job cut statistics are even worse, continuing to shake the market and depress sentiment. Adding another weak labor market data will only deepen people's concerns about the health of the U.S. economy and trigger stock market panic selling.

Therefore, although the non-farm unemployment rate in August slightly decreased to 4.2%, breaking the four-month upward trend, and the wage growth year-on-year increased by 3.8%, moving away from the two-year low, these are considered "good news", but market participants are more focused on the negative side of the data.

For example, the U6 unemployment rate, which reflects the "underemployment rate", rose to 7.9%, the highest level since October 2021. The growth rate of the education and healthcare industries, which are the pillars of employment growth in August, was the smallest since 2022. The employment participation rate of prime-age workers aged 25 to 54 decreased for the first time since March. In the past three months, the private sector employment has only increased by an average of 0.096 million people, the first time it has dropped below 0.1 million since the outbreak of the COVID-19 pandemic.

Betsey Stevenson, former Chief Economist at the U.S. Department of Labor, said in a media interview, "Currently, the non-farm employment growth in the United States is actually coming from three sectors: leisure and hospitality, healthcare and education services, and government. We have not seen much growth in business and professional services, which I think indicates that the economy is slowing down."

Some analysts believe that the market has entered a new paradigm, shifting its focus from inflation to growth, and that bad economic news is now detrimental to the stock market.

There are also analysts who believe that the underlying reason behind the market tension on Friday is that stocks and bonds are much more sensitive to economic indicators than in the past. Because investors know how important the prospect of a "soft landing" is for the U.S. economy, market sentiment fluctuates so dramatically. Any slight changes in economic data are amplified into concerns about a recession or fears of a sharp rebound in the stock market after temporary relief.

The above analysis suggests that we are entering a new market paradigm, in which two main themes emerge: a shift in focus to economic growth rather than inflation, and previously unpopular stocks outperforming market stars driven by expectations of the Federal Reserve's upcoming rate cut.

As Johanna Kyrklund, Chief Investment Officer at Schroders, said, six months ago the risk of a U.S. economic recession was zero, but now the risk is that the weakness in low-income households is beginning to affect the entire economy. And even if the Federal Reserve begins to cut interest rates, the market will remain highly sensitive to signs of economic weakness as the risk of a recession is likely to persist for quite some time.

The focus on economic weakness is also reflected in the changing relationship between stocks and bonds. When the market is concerned about inflation, good economic news is usually bad news for the stock market, as it implies upward pressure on prices and Fed rate hikes.

Now, good economic news is beneficial for the stock market because it alleviates concerns about economic growth and is expected to lead to interest rate cuts. Conversely, bad economic news is now detrimental to the stock market.

Therefore, the correlation between the S&P 500 index and the 10-year US Treasury yield has reversed after maintaining a year-long relationship. Stock and bond yields vaguely show a trend of moving in the same direction rather than opposite directions as before.

"New Fed Communication" indicates that non-farm payrolls cannot indicate the size of a rate cut in September, and Fed officials have not explicitly mentioned a substantial rate cut.

In addition, the second reason for the sharp drop in US stocks on Friday is probably the latest non-farm payroll data and subsequent speeches by several Fed officials, which still cannot specify the exact magnitude of the Fed's rate cut in September, but only ensure that "the rate cut will definitely happen, clearing the way for it."

Even well-known financial journalist Nick Timiraos, who is known as the "New Fed Communication", stated that the non-farm report is unclear and whether the Fed will cut rates by 25 or 50 basis points in September is still unknown.

"Overall, the non-farm data has not deteriorated enough to shift the market's baseline expectations for a 50 basis point rate cut, but considering the revised data, it is not sufficient to convincingly dispel speculation about a larger rate cut."

In recent weeks, the biggest question has been whether the summer impact reflected in the data is temporary (perhaps due to Hurricane Beryl suppressing hiring activity) or evidence of an overall economic slowdown.

(I can only say that) this summer's recruitment activities have slowed down, and the Fed's interest rate cut is inevitable.

Looking at the comments of several Fed policymakers after the release of nonfarm payrolls, they did indicate that a rate cut in September is certain, but their affirmation of the health of the economy and the mention of "acting cautiously" seem to contradict the market's bet on a 50 basis point rate cut after the nonfarm data surged. William Williams, the president of the Federal Reserve Bank of New York and one of the "big three" at the Fed, hinted that a rate cut would start at the traditional 25 basis points.

Many analysts have found that Williams, as a staunch ally of Powell, emphasized that the U.S. economy is still fundamentally stable, and the unemployment rate for this year is expected to remain around 4.25%, without showing a sense of urgency for a larger rate cut.

Even Raphael Bostic, a Federal Reserve governor who mentioned a "preemptive rate cut if appropriate", did not reveal any inclination to slash rates by 50 basis points in September. Instead, he described the economy as "performing well", with prospects for continued growth and a labor market that is "continuing to be weak but not worsening", and he expected that rate cuts would be "conducted cautiously".

Traders are wavering in their bets on the size of the rate cut in September, and Wall Street has also engaged in heated debates, which may leave the stock market without direction.

The so-called "front load" refers to aggressively cutting rates ahead of time based on the anticipation of a worsening economic situation, such as making a large rate cut at the beginning of the easing cycle to stabilize the economy before switching to more traditional 25 basis point rate cuts.

After the release of the nonfarm payrolls, the market did increase its overall bet on the size of the Fed's rate cut for this year, but it is still undecided whether the rate cut in September will be 25 or 50 basis points. In the end, the more traditional pace of rate hikes prevailed over more aggressive expectations. However, the market believes that there may be a 50 basis point rate cut in November, with a total of about 4.5 rate cuts of 25 basis points each before the end of the year.

Some analysts believe that many investors initially thought that the August nonfarm payrolls would indicate the magnitude of this month's rate cut, but the data turned out to be neither good nor bad, showing a significant slowdown in job growth but almost no change in the unemployment rate. This has kept traders in an uncertain state and unable to provide support for the stock market, which may lead to a subtle disappointment with the inability to cut rates by 50 basis points.

Scott Wren of Wells Fargo & Co's Investment Research Institute said that the financial markets have shifted their focus to how much the Federal Reserve will relax its policies and the pace of economic slowdown. Short-term volatility is expected to continue.

Chris Larkin of Morgan Stanley's E*Trade division also said that August non-farm payrolls in the United States fell short of expectations, which could boost investors' expectations of a 50 basis points rate cut by the Federal Reserve in September. However, it is still a while before the FOMC policy meeting, and there may still be no consensus at the moment. The current basic assumption is still that the cautious Federal Reserve will cut interest rates by 25 basis points in September, and the market may remain sensitive to "subsequent data indicating an excessive cooling of the U.S. economy".

Wall Street is engaged in a fierce debate over whether August non-farm payrolls and recent weak data can effectively support the Federal Reserve's decision to cut interest rates by 50 basis points in September.

Former Treasury Secretary Summers, a whistle-blower on high U.S. inflation, said that weak non-farm payrolls made the Federal Reserve closer to a 50 basis points rate cut in September. However, David Kelly, Chief Global Strategist at JPMorgan Asset Management, does not agree with launching a loose monetary policy cycle with a larger rate cut:

"I strongly believe that the first interest rate cut should only be 25 basis points. If the Federal Reserve cuts rates by 50 basis points, it will make everyone feel uneasy about the (degree of economic deterioration)... For psychological reasons, I think it's much better for them to cut rates gradually."

Torsten Slok, Chief Economist at Apollo Global Management, believes that the market's expectation of a 50 basis points rate cut in September is overreacting, reflecting excessive concerns about economic recession. The August non-farm report shows that there are no clear signs of recession, and "the unemployment rate is declining, so there is no need for a substantial 50 basis points rate cut."

Seema Shah, Chief Global Strategist at Principal Asset Management, said that for the Federal Reserve, the key decision is to determine which risk is greater: whether a 50 basis points rate cut will reignite inflationary pressures, or a 25 basis points rate cut will bring recession risks. However, "overall, in the case of low inflationary pressures, the Federal Reserve has no reason not to act cautiously and front-load (a substantial) rate cut."

"Recession theorists" are gaining the upper hand, reinforcing expectations of a classic stock market softening in the fall, with the end of the inverted yield curve in U.S. bonds implying a recession.

As for the other reasons for the sharp drop in US stocks on Friday or this week, media reports indicate that in September, the bears seem eager to take the lead before the yet unseen economic downturn, despite the continued support of soft landing arguments by multiple data sources. However, the voices of the "recessionists" are currently louder and more dominant, which may exacerbate the "classic weak stock market trends" seen in September and October over the past four years.

The bearish arguments include, on the one hand, Goldman Sachs claims that September is not only the weakest month of the year in performance, but also the two-week trading period in the second half of September is usually the worst performing period for the S&P 500 index. At the same time, the exceptionally strong trend of corporate share buybacks this year may soon slow down, as companies will enter a silent period of buybacks for several weeks before the next earnings release, the lack of activity will weigh on the stock market.

In addition, US stock indices, especially the darling of capital over the past year, popular technology stocks, still have relatively high valuations. The "major problem is that market prices are still expensive", and this week's price drop has not had a significant impact on overall valuations. The "painful trading" that makes everyone uncomfortable will lead to further market declines, which is a natural result of high valuations and economic slowdown.

It is worth noting that on Friday, the yield of the two-year US Treasury bond has been lower than the yield of the 10-year benchmark bond, indicating an end to the key yield curve inversion.

Street Signs previously mentioned that according to Dow Jones market data, since July 1, 2022, there has not been a long-term scenario where long-term bond yields are higher than short-term bond yields at the close. Once this occurs, it will end the longest period of yield curve inversion on record. As of this Thursday, the curve has been inverted for 545 consecutive trading days.

Analysts have also pointed out that the soft labor data has fueled bets on a Fed rate cut, temporarily ending the yield curve inversion. However, historically, when the yield curve inverts, it signals economic troubles ahead, which may not be entirely positive for the stock market:

"Many analysts point out that while the end of the long-term yield curve inversion usually occurs when the Fed starts cutting rates, since the Fed often eases policy only when the economy is facing difficulties, the end of yield curve inversion may actually increase investor concerns about an economic downturn, which is a negative signal for the stock market.

Editor/Emily