The Fed's U-turn has been on everyone's lips lately, which is unsurprising, considering that the US stock market has been on a rollercoaster ride after the first interest rate hike in March 2022, making investors stressed and anxious.

When the rate hike cycle seemed to be coming to an end in the first half of 2023, the market once again became unstable due to high core CPI and hot jobs data, leaving investors pondering whether an "increasing employment rate" was a clear indication of impending interest rate hikes, and what their next course of action should entail.

To understand the situation better, let's take a closer look at recent developments in the job market.

The latest US June jobs report from payroll processing firm ADP indicates a remarkable growth of 497,000 in private sector jobs, marking the most significant monthly gain since July 2022. This figure has doubled the Dow Jones consensus estimate of 220,000 and is notably higher than the downwardly revised 267,000 job addition seen in May. This suggests that the fundamentals of the US labor market remain strong and well above expectations.

Subsequently, Friday's official June payrolls report released nonfarm numbers were slightly lower than expected, but wage growth slightly exceeded expectations, showing the "stubbornness" of inflation.

The promising employment data triggered an immediate market response: the three major indexes of the US stock market simultaneously experienced a decline, US Treasury yields surged, and gold prices came under duress.

What was the potential reason for such an intense reaction in the market?

Let's begin by reviewing the analysis method we learned in the "Labor Market Basics" course.

● Determine which stage the US economy is in

Different stages of the economic cycle have varying impacts on employment and the stock market.

● Analyze the Fed's monetary policies

If the employment data is encouraging, the Fed may adopt measures to control inflation or boost economic growth.

● Evaluate the latest job market data

This can help us better understand how the stock market may respond to its changes.

● Consider potential changes in the future labor market

For example, changes in demographics can significantly impact employment rates.

● Re-examine stock investment strategies based on the above analysis

We can adjust our investment strategies according to the current economic conditions.

Let's break it down step by step.

To begin with, what is the current stance of the Fed?

The minutes of the June meeting released on July 5th revealed that almost all Fed officials had expressed the possibility of further tightening monetary policy.

Given the hawkish position of the Fed, should we see weak employment data, any plans to resume interest rate hikes will likely be put on hold? Conversely, if employment figures are encouraging, the Fed will probably raise interest rates.

Coincidentally, the explosive employment data has increased the likelihood of interest rate hikes, in line with the Fed's expectations.

According to the FedWatch, a tool that measures the likelihood of a rate hike by the Fed, the probability of a 25 basis point increase was only 52.8% a month ago. Still, these odds have been increasing every day and now stand at 92%. This suggests it is highly possible that interest rates will be raised soon.

The policy stance of the Fed has also raised a series of concerns as market risk appetite continues to cool in line with expectations of interest rate hikes. The trend is reflected by the sharp rise in the VIX volatility index, commonly known as the "Wall Street fear index."

Additionally, panic sentiment can be observed across different markets, including stocks, bonds, and commodities.

Let's start with the bond market. Investors have been selling bonds on expectations of interest rate hikes, causing the yield on the two-year Treasury bonds to hit a new high since 2007!

This indicates that the US borrowing cost has reached a new high, and a potential technical recession may appear.

Furthermore, The spread between two-year and 10-year US Treasury bond yields hit the highest level since 1981, deeper than the inversion during the US regional banking crisis in March. The inversion may indicate an economic downturn is on the horizon.

Regarding the stock market, July 6th marked the worst performance for the Dow industrials and the S&P 500 since May.

As we discussed in the Labor Market Course, when the Federal Reserve tightens monetary policy to control inflation, a robust job market can potentially trigger a stock market crash. This is because strong employment is often seen as a signal for more aggressive interest rate hikes, which could lead to lower stock prices.

On July 6th, investors were concerned that the Fed might raise interest rates during the next FOMC meeting, which could have contributed to this situation.

After delving into these details, what will happen to the market?

The answer lies in the heavyweight inflation report, which will play a decisive role in determining whether interest rates are raised in July.

Although recent data show that inflation is decreasing, it is still higher than the Fed's 2% target. This makes changing the trajectory of US interest rate hikes challenging, and the dollar may rise again as a result.

But investors don't need to be too pessimistic. On the one hand, most Federal Reserve officials have indicated that even if there are further interest rate hikes, they will be taken at a slower pace and won't be as aggressive as last year. On the other hand, despite the possibility of an economic recession, it is unlikely that the US economy will experience a hard landing, especially with the hot numbers of the labor market.

Overall, it appears the short-term direction of the US stock market will be determined by the confrontation between economic resilience and expectations of tough policies.

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