Stocks Tumble as Jobs Report Leaves Investors Bracing for a Big Rate Increase

Signs of strength in the labor market are normally a good thing for investors. But fresh data Friday served only to cement expectations that the Federal Reserve will need to slow the economy further to bring down inflation, weighing on stock prices.

The S&P 500 recorded its worst day since mid-September, falling 2.8% on Friday, dragged down by interest rate-sensitive sectors including technology stocks, although more than 95% of the stocks in the index ended the day in the red.

The Nasdaq composite, heavily weighted toward tech-stocks, fell 3.8%, while government bond yields, indicative of the future path of interest rates, rose and the dollar strengthened.

American employers added 263,000 jobs in September, down from 315,000 in August, the Labor Department said early Friday. Although the slight slowdown in hiring offered another signal that the Fed’s efforts to cool the economy and reduce inflation were having an effect, it was balanced against a drop in the unemployment rate to 3.5% from 3.7%, reinforcing a sense that the labor market remains robust.

Although that is typically positive, at the moment a resilient labor market is bad news for investors, because it points to the need for the Fed to raise interest rates even more than it already has. Higher rates, in turn, raise costs for companies, weighing on stock prices.

“At this point, the market is looking for any reason for the Fed to blink,” said Ian Lyngen, an interest rate strategist at BMO Capital Markets. “This report didn’t give it to us.”

Despite Friday’s drop, a rally Monday and Tuesday left the S&P 500 1.5% higher for the week, after three straight weeks of losses. Some investors had started to consider the idea that the Fed might veer from its path of higher interest rates, as economic data had begun to show the economy cooling.

But policymakers quickly dashed any expectation of an immediate policy shift in the run-up to Friday’s data release, cautioning against the idea that the Fed’s fight against inflation was nearly over. For investors, the fresh numbers confirmed what they had already been told.

Market expectations of how much the Fed will raise interest rates when officials meet in November nudged upward Friday, predicting another three-quarter-point increase. Such an increase was seen as unusually large not long ago. But if the Fed raises rates by that much next month, it would be the fourth time this year that it has done so.

“I would say this is what the Fed is going to do,” Andrew Brenner, head of international fixed income at National Alliance Securities, said of forecasts for another aggressive Fed rate increase. He added that it would take a significant slowdown in consumer prices – a widely watched gauge of inflation – when the latest data is released next week to alter policymakers’ path. “I don’t see anything to deter them at this point.”

The Fed has already raised interest rates rapidly this year, alongside other central banks around the world. They are all fighting high inflation, stemming from the reopening of economies after the start of the pandemic, and amplified by soaring energy prices after Russia’s invasion of Ukraine.

The consensus among investors is for interest rates to rise another 1.25 percentage points before the end of the year, reaching a peak around 4.6% next year, in line with Fed policymakers’ forecasts. But investors continue to bet that an economic slowdown, alongside falling inflation, could prompt the central bank to begin lowering rates before the end of 2023, sooner than Fed officials have forecast.

The concern is that a more sustained period of higher interest rates could destabilize the financial system, leading to the kinds of whipsaw price movements that sent shock waves through British government bond markets last month.

One measure of the ferocity of price movements, or “volatility,” in the U.S. government bond market closed out the week near levels last seen during the worst of the pandemic-induced sell-off in March 2020. Stock price volatility also remains elevated, according to the CBOE’s Vix Volatility Index, otherwise known as Wall Street’s “fear gauge.”

The Fed “would like to slow down,” said Ellen Zentner, chief U.S. economist at Morgan Stanley. “It’s dangerous when you go at this speed for too long. But I think this report is another piece of evidence that they are going to deliver another outsized hike in November.”

Investors will be watching for clearer signs on how higher interest rates are affecting corporate profits as quarterly earnings reports for the third-quarter ramp-up next week. As things stand, the S&P 500 remains more than 23% below where it started the year.

Elsewhere on Friday, Europe’s Stoxx 600 index slumped 1.2%, Japan’s Topix dipped 0.8% and China’s CSI 300 fell 0.6%.