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Surprise job gains help stocks overcome Middle East worries

A late rally helped large-cap stocks notch their fourth consecutive weekly gain despite growing tensions in the Middle East and news of a dockworkers’ strike at Eastern seaports. While weighing on sentiment generally, the prospect of a wider war in the Middle East sent oil prices to their highest level in about a month, benefiting energy shares. Conversely, the Middle East worries appeared to weigh on cruise line stocks and the consumer discretionary sector. Nike also fell sharply on Wednesday, after the company withdrew its full-year sales guidance.

According to T. Rowe Price traders, what started as a relatively quiet trading week quickly picked up steam as U.S. markets opened on Tuesday, following reports that Iran was preparing to launch a retaliatory ballistic missile attack against Israel. Later that day (evening in the Middle East), Iran fired nearly 200 missiles directly at Israel. While many of the missiles were intercepted, there were several hits in the southern and central parts of the country and threats of “more devastating attacks” if Israel responded. Stocks pulled back sharply, with the S&P 500 Index down 1.38% at the close of trading. Markets stabilized on Wednesday, however, perhaps because worst-case scenarios failed to materialize.

Tuesday brought another complication for the markets in the form of the start of a walkout by the International Longshoremen’s Association, which effectively closed operations at every major port on the East and Gulf Coasts, which together represent the capacity to handle as much as half of all U.S. trade volumes. Fears of a new round of broken supply chains and inflationary pressures dissipated on Thursday evening, however, following news of a temporary agreement that will delay any walkout until mid-January.

Hiring remains robust but so do wage gains

Nevertheless, the news seemed to be overshadowed as trading resumed Friday morning by the closely watched monthly nonfarm payrolls report. The Labor Department announced that employers had added 254,000 jobs in September, nearly twice the consensus estimates and the most since March. August’s gain was also revised higher. The household survey also brought better-than-expected news, with the unemployment rate unexpectedly ticking lower to 4.1%.

Although stocks appeared initially to rise on the news, investors seemed unsure how to react to the data, perhaps because of the inflationary implications of an upward surprise in wage figures. Average hourly earnings rose 0.4% in September on the heels of an upwardly revised 0.5% gain in August—the fastest pace since the start of the year.

While generally upbeat, the payrolls report also revealed another monthly decline in manufacturing jobs, the fifth such contraction so far in 2024. On Monday, the Institute for Supply Management (ISM) reported that its gauge of factory activity had unexpectedly remained steady in September at 47.2, which is still firmly in contraction territory (levels above 50.0 indicate expansion). In stark contrast, the ISM’s gauge of services sector activity, reported Wednesday, jumped much more than expected to 54.9, its highest level in 19 months. Less favorably, the report also showed price pressures in the sector increasing to their highest level since the start of the year.

Jobs report pushes Treasury bond yields to highest levels in almost two months

The jobs report led to a spike in longer-term bond yields, with the yield on the benchmark 10-year U.S. Treasury note spiking to its highest intraday level (3.98%) since August 8. (Bond prices and yields move in opposite directions.) Despite a busy primary calendar, municipal bonds outperformed Treasuries over the week, aided by continued inflows.

Meanwhile, issuance was oversubscribed in the investment-grade (IG) corporate bond market during the week, as demand for IG credit remained robust. After starting the week at or near year-to-date tight levels, credit spreads remained unchanged to slightly tighter throughout the week. According to our traders, broader risk-off sentiment due to escalating geopolitical tensions in the Middle East weighed on the high yield bond market. They also noted that primary market issuance was subdued after a few deals were announced early in the week.

In local currency terms, the pan-European STOXX Europe 600 Index ended 1.80% lower as an escalation of conflicts in the Middle East made investors cautious. Major stock indexes also fell sharply. Italy’s FTSE MIB dropped 3.26%, France’s CAC 40 Index declined 3.21%, and Germany’s DAX lost 1.81%. The UK’s FTSE 100 Index eased 0.48%.

ECB October rate cut in view as growth and inflation slow

Purchasing managers’ indexes (PMIs) pointing to weaker eurozone growth and inflation falling below the European Central Bank’s (ECB) 2% target combined to strengthen expectations of an interest rate cut in October. Annual headline inflation in the eurozone slowed to 1.8% in September, the lowest level since April 2021 and below forecasts for 1.9%. Core inflation also eased to 2.7% from 2.8% in August. The eurozone composite PMI reading for September was revised higher to 49.6 from 48.9. (PMI readings less than 50 indicate a contraction in activity.)

ECB leaders appear to signal easier policy

Comments from ECB officials indicated that their gradualist approach to easing monetary policy may be shifting. ECB President Christine Lagarde, for example, hinted that borrowing costs might soon be lowered. "The latest developments strengthen our confidence that inflation will return to target in a timely manner," she told a European Union parliamentary hearing. "We will take that into account in our next monetary policy meeting in October." Executive Board member Isabel Schnabel suggested that inflation is increasingly likely to ease back to the 2% target and dropped her usual warning that rates must not be cut too early.

BoE’s Bailey raises prospect of more policy easing but Pill still cautious

Bank of England (BoE) Governor Andrew Bailey said in an interview with The Guardian newspaper that the bank could become “a bit more aggressive” in lowering borrowing costs if the inflation rate continues to fall. However, Chief Economist Huw Pill warned against cutting rates too far and too fast. He said inflation among services firms and pay growth represented "a continued source of concern."

Japan’s stock markets suffered sharp losses around the start of the week as investors digested the country’s latest political developments. Shigeru Ishiba won the Liberal Democratic Party’s (LDP’s) closely contested leadership election on Friday, September 27—with the surprise win over Sanae Takaichi in a runoff vote making Ishiba Japan’s new prime minister (PM). His monetary policy views are considered slightly hawkish, leading the yen to initially strengthen and sending stock markets lower.

While markets recouped some of the lost ground over the week as Ishiba adopted a more dovish tone than had been anticipated, weighing on the yen, the Nikkei 225 Index and the broader TOPIX Index still registered respective declines of 3.0% and 1.7% over the week. The yen weakened to around JPY 146 against the USD, from about JPY 142 at the end of the previous week.

Despite a generally dovish tone being adopted by Japan’s top government officials, the yield on the 10-year Japanese government bond rose to 0.87%, from the prior week’s 0.80%, tracking U.S. Treasury yields higher as strong U.S. economic data tempered expectations that the Federal Reserve would cut interest rates aggressively.

New PM comments on monetary policy, signals economic policy continuity

On the first full day of Ishiba’s new government, the PM commented on monetary policy. While careful not to encroach on the Bank of Japan’s (BoJ’s) independence, he said that environment is not ready for an additional interest rate hike and stressed his hope that the economy will make progress in a sustainable manner toward the end of deflation with the monetary easing trend in place.

On the economic policy front, Ishiba pledged to maintain continuity with his predecessor, Fumio Kishida, calling for intensive efforts to overcome deflation without the risk of reversing the virtuous cycle. Ishiba also instructed his cabinet to draw up a stimulus package to support households struggling with inflation and to boost regional economies. This comes ahead of a snap election that has been called for October 27, where the LDP’s dominance and general backing are likely to remain strong.

Chinese stocks surged in a holiday-shortened week as optimism about Beijing’s comprehensive support measures offset disappointing data. The Shanghai Composite Index gained 8.06%, while the blue chip CSI 300 Index rose 8.48%. In Hong Kong, the benchmark Hang Seng Index climbed 10.2%, according to FactSet. Markets in mainland China were closed on Tuesday for the National Day holiday and will reopen on Monday, October 7. Hong Kong markets were closed Tuesday but reopened Wednesday.

China’s factory activity contracted for the fifth consecutive month amid weak demand. The official manufacturing Purchasing Managers’ Index (PMI) rose to an above-consensus 49.8 in September from 49.1 in August, according to the country’s statistics office but remained below the 50-mark threshold separating growth from contraction. The manufacturing PMI has now been in contraction for all but three months since April 2023, according to Bloomberg. The nonmanufacturing PMI, which measures construction and services activity, fell to a lower-than-expected 50 in September, its lowest level in 21 months.

Separately, the private Caixin/S&P Global survey of manufacturing activity eased to 49.3 in September from the prior month’s 50.4, its lowest reading since July 2023 and below economists’ forecasts. The Caixin services PMI fell to 50.3 from 51.6 in August but remained in expansion.

The value of new home sales by the country’s top 100 developers fell 37.7% in September from a year ago, accelerating from August’s 26.8% drop, according to the China Real Estate Information Corp. However, market sentiment improved after three of China’s largest cities relaxed homebuying restrictions on the back of the central government’s extensive stimulus package unveiled the prior week. On Sunday, Guangzhou became the first so-called Tier 1 city to remove all restrictions on home purchases. Shanghai, China’s financial center, and Shenzhen, the country’s tech hub, also announced reductions in minimum down-payment ratios for first and second homes in an effort to stoke demand.

Poland

Elevated inflation likely until summer 2025

Early in the week, Poland’s government reported that the inflation rate in September was 4.9%. This was in line with expectations, though it was higher than August’s 4.3% reading.

According to T. Rowe Price credit analyst Ivan Morozov, the higher inflation reading primarily reflects base effects from 2023. Still, he notes that core inflation remains above the central bank’s target and that core inflation momentum keeps running at about 4%. He also believes that base effects are likely to keep inflation elevated at close to 5% until summer 2025. From the central bank’s point of view, Morozov believes that this latest inflation reading will prompt policymakers to keep short-term interest rates steady until at least the early part of 2025.

Türkiye Inflation declining, but tight monetary policy likely to continue through year-end

The Turkish government reported this week that the inflation rate in September was 2.9% month over month. As a result, the annualized consumer price index (CPI) reading fell to 49.5% in September from 52% in August. This means that headline inflation is not only below 50% for the first time since July 2023 but also below the central bank’s benchmark interest rate, the one-week repo auction rate, currently at 50.0%.

T. Rowe Price analysts expect Turkish inflation to continue dropping through the end of the year, but it will likely remain above the central bank’s current target of 38%. They also believe that monetary policy will remain tight through year-end, though it is possible that the central bank could begin a rate-cutting cycle with a modest reduction in November or December. Policymakers, however, might decide to keep various macro prudential regulations in place in order to restrain credit growth.

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