Stocks rise as investors cling to hopes for US rate cuts

Global stocks advanced Monday, fueled by heightened expectations for a September Fed rate cut (85% probability) after July's weak U.S. nonfarm payrolls report, which included significant downward revisions. This data spurred concerns over U.S. economic data reliability and the politicization of monetary policy, exemplified by President Trump's firing of the Labor Statistics head. While two-year Treasury yields sharply declined Friday, the dollar saw mixed trading, and oil prices continued their slide on increased OPEC+ output.

Analysis

Global equity markets are exhibiting a classic 'bad news is good news' response, rallying on the heightened probability of a U.S. Federal Reserve rate cut in September, which markets have priced at 85%. This follows a U.S. July nonfarm payrolls report that not only missed expectations but also included substantial downward revisions for the prior two months, causing the three-month average job growth to collapse from 231,000 to 35,000. This sharp deterioration signals a potentially more pronounced weakening in the U.S. labor market, a sentiment that triggered a significant 25 basis point drop in two-year Treasury yields. However, this dynamic is clouded by escalating concerns over the politicization of U.S. institutions. The firing of the head of Labor Statistics and the prospect of a new presidential appointee to the Fed Board have cast doubt on the credibility of economic data and the central bank's independence, introducing a significant risk premium. Cross-asset reactions have been volatile, with the U.S. dollar attempting a modest recovery after its largest one-day fall since April, while oil prices are declining separately due to an OPEC+ decision to increase output.

Key Decisions for Investors

• The current equity rally is driven by liquidity expectations rather than fundamentals; therefore, investors should monitor for any signs that deteriorating economic data is beginning to negatively impact corporate earnings outlooks, which could reverse the trend.
• Given that markets have aggressively priced in a September rate cut, the risk-reward for long positions in short-duration government bonds has diminished, and positions should be managed for potential volatility around upcoming Fed communications.
• Factor in heightened political risk premium, as concerns over the credibility of U.S. economic data and Federal Reserve independence could lead to unpredictable market reactions and increased volatility in currency and rate markets.
• Note the divergence between weakening U.S. economic indicators and rising oil supply from OPEC+, which could create headwinds for inflation-sensitive assets and energy sector equities.