A surprisingly weak July U.S. jobs report Friday added to growing concerns that the American economy is slowing fast, sparking a second straight session of sharp stock declines and an even more ferocious pullback in bond yields.
The soft reading on employment had market observers questioning whether the U.S. Federal Reserve has made a policy mistake by resisting rate cuts so far during this economic cycle.
The U.S. two-year Treasury yield - which is particularly sensitive to Federal Reserve monetary policy - has plunged half a percentage point since just this past Wednesday, marking its largest weekly decline since March 2023. Both Canada’s two-year and five-year bond yields fell to their lowest in more than two years, signaling further downward pressure on fixed mortgage rates.
The reassessment of the strength of the U.S. economy, and the policy moves that now may be required to ward off a recession, reverberated in Canada, where money markets are now pricing in a near certainly of a further rate cut by this country’s central bank at its next policy meeting in September. The Bank of Montreal revised its forecasts to now call for the Bank of Canada’s overnight rate to fall by another full percentage point by January.
The Labor Department said nonfarm payrolls increased by 114,000 jobs last month, well short of the 175,000 average forecast by economists, and the at least 200,000 that economists believe are needed to keep up with population growth. The unemployment rate jumped up to 4.3%, near a three-year high.
“There was absolutely no silver lining or redeeming feature in this report. The Fed is behind the economic curve to the same degree it was behind the inflation curve back in 2021 and 2022, and there will be hell to pay for this policy misstep — especially given the tense political environment with an election just three months away,” David Rosenberg, founder of Rosenberg Research, said in a research note.
The weak jobs data also triggered what is known as the “Sahm Rule,” seen by many as a historically accurate recession indicator.
Traders are now pricing in reasonable odds that both the U.S. Federal Reserve and the Bank of Canada may need to cut rates by more than 25 basis points at upcoming meetings.
The U.S. rate futures market is pricing in a 73% chance of a 50 basis point cut at the Fed’s September meeting, up from 20% late on Thursday, according to LSEG calculations. The market has also priced in about 120 bps of easing this year, from 75 bps on Thursday.
The Bank of Canada has already cut its trend-setting overnight rate by a quarter of a percentage point twice this year. Overnight index swap markets are now pricing in 100% odds of at least a further quarter point cut at the bank’s next policy meeting on Sept. 4, and about 27% odds that it could be a larger 50 basis point cut, according to LSEG data.
The U.S. Federal Reserve kept interest rates unchanged Wednesday but signaled it could start lowering it as soon as its next policy meeting in mid-September. That decision, however, was followed on Thursday by surprisingly soft readings on the manufacturing sector and weekly jobless claims. Then came the July nonfarm payrolls report on Friday.
“The sudden signs of much chillier growth caught the equity market totally unaware,” said Douglas Porter, chief economist with the Bank of Montreal, in a note. “Suddenly, bad economic news has become bad news for stocks.”
“We believe that the case for restrictive rates has almost vanished, and the Fed will now proceed with haste to get back to something approaching neutral,” Porter added. Neutral is a policy rate that is neither stimulating nor holding back the economy.
Mr. Porter thinks the Fed will now cut rates at each of its final three meetings of the year, and the first two of next year. That will open the door for the Bank of Canada to “match its own dovish stance with faster action.” He thinks the bank’s overnight rate will be down to 3% by mid-2025 from the current 4.5%.
On Friday, Canada’s main stock index posted its biggest decline in six months, as resource and technology shares paced a broad-based selloff. The S&P/TSX composite index ended down 495.58 points, or 2.2%, at 22,227.63.
The index has pulled back 3.8% since notching on Wednesday a record closing high at 23,110.81. For the week, the index was down 2.6%, after five straight weekly gains.
The Toronto market’s technology sector tumbled 4.5% as investors worried about the valuations of some high growth companies. A number of analysts cut their target price on Lightspeed Commerce Inc, with its shares ending 9.4% lower.
Energy was down 4.3% as the U.S. data clouded the demand outlook for oil. U.S. crude futures settled 3.7% lower at $73.52 a barrel.
The materials group and heavily weighted financials both lost 2.4%.
Auto parts supplier Magna International Inc missed estimates for second-quarter results. Its shares fell 6%.
Of the 10 main sectors in Toronto, only utilities ended higher, rising 0.1%. The sector is dominated by high-dividend paying stocks with big debt loads that could particularly benefit from rate cuts.
The Dow Jones Industrial Average fell 610.71 points, or 1.51%, to 39,737.26, the S&P 500 lost 100.12 points, or 1.84%, to 5,346.56 and the Nasdaq Composite lost 417.98 points, or 2.43%, to 16,776.16.
Adding downward pressure was drop in Amazon, down 8.79%, and Intel, which plunged 26.06% after their quarterly results and disappointing forecasts.
The declines pushed the Nasdaq Composite down more than 10% from its July closing high to confirm the index is in a correction after concerns grew about expensive valuations in a weakening economy.
The S&P 500 closed at its lowest level since June 4. Both the benchmark S&P index and the blue-chip Dow suffered their biggest two-day slides since March 2023.
The small cap Russell 2000 index slumped 3.52% to close at a three-week low and saw its biggest two-day drop since June 2022.
Chip stocks also continued their recent downdraft, and the Philadelphia SE Semiconductor Index closed at a three-month low after its biggest two-day slide since March 2020.
The CBOE Volatility index, also known as Wall Street’s “fear gauge,” reached its highest mark since March 2023.
Some market participants viewed the sell off as a chance to pickup stocks at cheaper prices. UBS strategist Jonathan Golub said in a note to clients on Friday that market returns are greatest when the VIX is extended and represents a near-term buying opportunity.
Among the few bright spots, Apple rose 0.69% after posting better-than-expected third-quarter iPhone sales and forecasting more gains, betting on AI to attract buyers.
Of the 11 major S&P 500 sectors, defensive names such as consumer staples, utilities and real estate were the only advancers, with the consumer discretionary sector leading declines as Amazon weighed heavily, for its biggest two-day drop since June 2022.
With files from Reuters