Weak US jobs data justifies Fed rate cut, says analyst

Key Concepts

• Labor Market Data: ADP payrolls, weekly jobless claims, layoffs.
• Federal Reserve Policy: Interest rate cuts, policy path, inflation targets.
• Economic Indicators: PCE report, inflation trends, tariffs.
• Asset Classes: Government bonds, equities (S&P 500, US tech sector), gold.
• Market Dynamics: Risk sentiment, corporate margins, wage pressures, earnings growth, valuations, Santa rally, broadening market leadership.
• Economic Factors: Tax cuts, US debt levels.

Labor Market Mixed Signals and Fed Policy Path

The labor market is presenting a mixed picture. While ADP payroll data has been weak, with four out of the last six months showing negative numbers, weekly jobless claims have fallen to their lowest level in three years. This weakness in labor conditions, according to Anthony Raz, justifies the Federal Reserve's potential concern and positions them for another interest rate cut in December. Investors are largely pricing in this cut, with the ongoing debate focusing on the extent of further cuts in 2026. Raz's baseline expectation is for a couple more rate cuts in 2026, with markets pricing in slightly more. This shift from policy headwinds (like tariffs) to tailwinds from rate and potential tax cuts is seen as a positive development for the US economy entering 2026.

Interpretation of Conflicting Labor Data and Corporate Margins

The conflicting signals in the labor market, such as low jobless claims alongside a high number of layoffs (over 1 million this year as reported by Challenger, Gray & Christmas), are interpreted as a "no hire, no fire" economy by many economists. This scenario is considered potentially acceptable as it allows for continued consumption, with employed individuals continuing to spend. However, Raz notes the risk that this could be a gradual pattern, with companies first slowing hiring before resorting to layoffs if conditions worsen. Despite this, corporate profits are currently good, and anticipated tax cuts are expected to further boost the economy in 2026, potentially benefiting corporate margins.

Inflation, Tariffs, and Fed's Risk Tolerance

The delayed PCE report is expected to show inflation slightly below 3%. While inflation remaining above the Fed's target is a concern, Raz believes the underlying core inflationary trends are in a "pretty good pattern." He suggests that tariffs have artificially bumped up the reported numbers. The Fed appears willing to take a risk, assuming these tariffs are temporary and the underlying trend is acceptable. This, however, places the Fed in an "uncomfortable position" due to the inherent risk.

Government Bonds and Yields

With 10-year Treasury yields moving back around 4%, government bonds offer "reasonable yields." Raz is not anticipating interest rate cuts to significantly drive down these yields. He attributes this to high US debt levels, expecting yields to remain around current levels. For bond investors, this means a decent yield with limited risk of yields increasing, especially with anticipated interest rate cuts.

Equity Market Momentum and Earnings Growth Outlook

The S&P 500 reclaiming key technical levels suggests bullish momentum. Raz views the current asset class landscape positively, with bonds, gold, and equities all performing well, and no immediate catalysts foreseen to disrupt this trend. While acknowledging concerns about equity valuations, he notes that such patterns can persist. Looking ahead to 2026, Raz forecasts strong earnings growth: approximately 13% for the US, 15% for Asia, and double-digit growth for Europe and Japan. This projected earnings growth is expected to support positive market performance, similar to 2025.

Broadening Market Leadership and Diversification

The US tech sector has been the primary market driver but has recently underperformed. Raz believes a broadening of market leadership is an important trend to watch for next year. With increased economic support from tax and rate cuts, it would be logical for more companies to participate in market gains. The current market's over-reliance on large tech companies is a concern, and broader participation would be a "very healthy sign." While remaining invested in tech, Raz recommends diversifying into more sectors in the coming year due to anxieties and things to watch.

Conclusion and Key Takeaways

The US economy is navigating a complex landscape of mixed labor market signals, with the Federal Reserve likely to cut rates in December and potentially more in 2026. While inflation remains a concern, underlying trends and the temporary nature of tariffs are factors the Fed is considering. Government bonds offer attractive yields with limited downside risk. The equity market is showing bullish momentum, supported by strong projected earnings growth across global markets in 2026. A key development to monitor is the broadening of market leadership beyond the tech sector, which would signal a healthier economic expansion. Diversification into other sectors is recommended for the coming year.