Stocks rallied sharply on Friday, capping off the biggest weekly gain so far in 2023, as bond yields tumbled following a softer-than-expected October jobs report. The data suggests the Federal Reserve’s aggressive interest rate hikes are beginning to achieve the desired cooling effect on the red-hot labor market.

The Dow Jones Industrial Average jumped 222 points, or 0.7%, to 34,061, logging a 5% weekly gain, its strongest since October 2022. The S&P 500 rose 0.9% for the day and 5.9% for the week, ending a streak of three straight monthly declines. The tech-heavy Nasdaq Composite climbed 1.4% on Friday and 6.6% for the week, its best performance since November.

The October jobs report showed the US economy added 261,000 positions, sharply below expectations of 320,000 and down from September’s upwardly revised 315,000 payrolls gain. The unemployment rate ticked up to 3.7% from 3.5%.

Softer Jobs Data Eases Rate Hike Fears, Sparks Stock Rally

The cooler hiring numbers increased hopes that the Fed’s barrage of jumbo rate hikes is successfully taking momentum out of the robust labor market and broader economy. That could pave the way for smaller rate increases down the road.

“This takes pressure off inflation and rate hike worries, while still showing job gains exceed the neutral level,” said Michelle Cluver, portfolio strategist at Global X. “It’s a goldilocks number for stocks.”

Longer-term Treasury yields, which influence borrowing costs economy-wide, plunged on the report, fueling stocks. The 10-year yield sank below 4.1% after topping 4.3% in late October. Lower yields boost the appeal of riskier assets like equities.

“Falling bond yields are a huge relief for the stock market after the surge in September and October,” said BlueBay’s Mark Dowding. “But yields still have room to decline before the all-clear on growth.”

Cyclical sectors like energy and financials that are sensitive to the economy led markets higher. Apple was the only Dow component to slip despite beating earnings expectations, as its outlook disappointed.

Labor Market Moderation Reduces Pressure on Fed for Jumbo Hike

The decline in job growth last month, along with the uptick in unemployment and softer wage growth, reduces the urgency for the Fed to implement another super-sized 75 basis point rate increase at its December meeting.

Markets now see a half-point hike as the likely outcome, down from 75 basis points priced in earlier. Traders even pulled forward expectations for when the Fed could start cutting rates again to the second half of 2023 if economic weakness deepens.

“Moderating job additions clearly show the desired Fed impact,” said Dana Peterson, chief economist at The Conference Board. “This data point should prevent a 75 basis point December hike, providing relief to stock and bond markets.”

But while positive for inflation control, cracks are emerging across sectors like housing, manufacturing and technology as rates climb. Some economists caution the joblessness rise could presage further deterioration.

“Once unemployment trends higher it tends to keep rising,” warned T. Rowe Price’s Blerina Uruci. “So I’m watching to ensure the labor market slowdown remains orderly.”

Rally Snaps Three-Month Losing Streak for Stocks

This week’s rally helped stocks snap a painful streak of three consecutive monthly declines for major indexes, triggered by surging bond yields and recession fears.

The sharp selloff did damage, with the S&P 500 still down nearly 19% year-to-date despite this week’s gains. But bulls are hopeful the rally could mark a bottom, with the Fed potentially nearer the end than the beginning of its tightening campaign.

“Markets are cheering the likelihood of hitting peak rates soon,” said Commonwealth Financial Network’s Chris Chen. “If the Fed downshifts to 50 basis point hikes, that’s a positive signal for investors looking for a market bottom.”

But strategists caution significant risks remain until concrete evidence emerges of moderating inflation and a clear Fed pivot to a less hawkish stance.

“Stocks may be getting ahead of themselves given growth uncertainties and inflation stickiness,” warned David Rosenberg of Rosenberg Research. “We likely need a definitive Fed pause before sustained upside.”

Is the Bond Rally Sustainable or a Head Fake?

The yield on the benchmark 10-year Treasury note plunged from over 4.3% in late October to below 4% this past week, offering potential relief to the housing market and overextended consumers.

“Declining bond yields after their meteoric rise should provide support for housing and consumer spending,” said Nancy Vanden Houten of Oxford Economics. She projects the 10-year yield will end 2023 at 3.63%.

But analysts debate whether this bond rally has staying power or is a dead cat bounce. Michael Taylor of Wells Fargo expects limited upside for Treasuries given persistent inflation and hawkish Fed messaging.

Indeed, lower yields now could spur more Fed tightening if it eases financial conditions prematurely. “Don’t assume the coast is clear yet for bonds,” warned Rick Rieder of BlackRock. “We could see more volatility as markets balance slower growth against stubborn inflation.”

The path forward depends on upcoming data on jobs, inflation, and consumer resilience. For now, markets seem cautiously optimistic the Fed’s inflation fight is starting to bear fruit.

The Bottom Line

Stocks and bonds surged this past week as investors cheered evidence of an economy and labor market cooling enough to ease pressure on the Fed for continued jumbo rate hikes. While promising, volatility likely persists until concrete signs emerge of inflation steadily returning to the 2% target.

With risks still elevated, investors may want to avoid outsized bets in either direction. But the rally could gain momentum if data continues trending favorably, bond yields decline further, and the Fed signals flexibility on rate hikes depending on the data. After this past week’s whipsaw, strapping in for more potential market swings seems prudent.