Last week, the global financial landscape was electrified by remarks from Jerome Powell, the chair of the Federal Reserve, at the annual central bank symposium held in Jackson Hole, Wyoming. Powell indicated that the time for interest rate cuts is imminent, primarily due to escalating risks in the labor market. This statement brought the likelihood of a rate cut in September closer to reality, propelling the stock markets into a frenzy.

In light of Powell's statements, the three major stock indices have recouped losses attributed to initial fears of recession earlier in the month. There is growing speculation on whether the anticipated loosening of monetary policy could enhance the markets, driving them back toward historical peaks.

As the Federal Reserve appears poised to reduce interest rates, the economic indicators and labor market trends have become the focal point of attention. Powell's remarks suggested that while the economy continues to grow steadily, new inflation and labor market data indicate a changing landscape. He emphasized the evolving nature of their dual mandate, noting, "The upward risks of inflation have diminished while the downward risks to employment have increased." This acknowledgment signals a potential pivot in monetary policy, with interest rate adjustments now hinging on forthcoming data and shifting risk assessments.

Advertisement

Data released by the U.S. Department of Labor indicated a downward adjustment in employment growth figures, with approximately 818,000 fewer jobs created over the past year than initially expected—the largest reduction since 2009. This trend highlights a labor market in transition, where traditional measures of job growth face unprecedented challenges.

Powell noted that although the unemployment rate has risen nearly one percentage point over the past year, this is largely due to a surge in labor supply and a slowdown in hiring rather than a surge in layoffs. Moreover, he stressed the Fed's commitment to stave off any further erosion of employment prospects. At the beginning of this tightening cycle, Powell had conveyed that some labor market "pain" was fundamental to controlling inflation. This perspective, however, now appears to have evolved.

Bob Schwartz, a senior economist at Oxford Economics, expressed in an interview that while employment growth may be weaker than previously projected, adjustments to non-farm payroll benchmarks would not significantly affect the Federal Reserve's stance as they largely reflect historical data. Schwartz also raised concerns that despite recent hiring trends, the labor market could be on shaky ground, failing to generate sufficient job opportunities to keep pace with the growing working-age population.

In the bond market, the long-term Treasury yields have dipped amidst expectations of monetary easing. The two-year Treasury yield, closely tied to interest rate forecasts, fell by 15.1 basis points to 3.91%, while the benchmark 10-year Treasury yield dropped by 8.6 basis points to 3.81%. Traders are increasingly betting on a significant rate cut in September, with futures indicating a 37% possibility of a 50-basis point cut—up from approximately 25% just a week prior. Nonetheless, a 25-basis point reduction remains the most favored scenario.

James Orlando, a senior economist at TD Securities, pointed out in his report that Powell did not substantially clarify the expected speed of interest rate cuts. However, he also noted that there seems to be little justification for a drastic cut of 50 basis points at this juncture.

Schwartz added that the messages from the July FOMC meeting minutes and Powell's Jackson Hole address clearly suggest the Fed's intention to cut rates in September. He emphasized that any significant negative surprises in labor market data between now and the meeting would need to occur for a larger cut to be considered viable. He believes the Fed is striving to navigate monetary policy amid uncertain data, adopting a cautious stance to prevent a further deterioration of the labor market.

On the stock market front, the anticipation of Federal Reserve rate cuts has fueled a continuation of the bullish trend seen in U.S. equities. Data from the Dow Jones showed that barring the energy sector, all major sectors recorded gains last week, with real estate, materials, and consumer discretionary sectors exceeding 2% growth. Other sectors such as industrials, healthcare, consumer staples, financials, and utilities also posted gains of over 1%.

The technology sector, particularly the stars of artificial intelligence, has seen a resurgence. Chipmaker Nvidia rebounded nearly 30% from its lower levels, lifting the Philadelphia Semiconductor Index into a technical bull market as market participants eagerly await the upcoming earnings reports.

Meanwhile, a regained appetite for risk has led to a stabilization of the Chicago Board Options Exchange Volatility Index (VIX), which quickly retreated after peaking at a four-year high at the beginning of the month. As of last Friday's close, the index has fallen over 70%, returning to levels below the long-term average, suggesting a rebalancing of investor risk appetite.

Fund flows indicate a forthcoming shift in monetary policy, bolstered by robust retail sales data, optimistic consumer sentiment, and moderate inflation figures, all of which bolster investor confidence. Data compiled by London Stock Exchange Group (LSEG) revealed that investors collectively purchased $5.97 billion in U.S. stock funds last week, marking the highest inflow in five weeks.

UBS Wealth Management shared in a report that with the labor market cooling faster than anticipated and inflation continuing to ease, the Federal Reserve is expected to initiate rate cuts in September followed by additional cuts in November and December. However, they caution that should the labor market falter further or consumer spending show significant weakness, a 50-basis point cut in September becomes a possibility. Historically, the Fed's rate cuts during non-recession periods have positively influenced the stock market, leading them to remain bullish on quality growth stocks.

Charles Schwab, in their market outlook, noted that while U.S. equities experienced a pullback at one point last week, Powell's dovish remarks rejuvenated the market's upward momentum. The anticipated policy shift mainly benefits interest-rate-sensitive sectors, such as the Russell 2000 Index. However, investors must navigate the typically bearish seasonal environment presented by August and September. Moreover, with the forward price-to-earning ratio of the S&P 500 now at 21.5, it may be challenging to achieve additional upward movement without an increase in earnings growth expectations.

This institution believes that attention in the coming week should initially focus on whether rotational trading gains traction again, alongside Nvidia's earnings report, which could invigorate the tech sector or potentially douse some enthusiasm if guidance comes in problematic, such as possible shipping delays from Blackwell. Overall, the bullish momentum observed in the early week may continue to receive support from the anticipated rate cuts, but volatility could ensue later in the week depending on Nvidia's performance and the market's subsequent reaction.