By Saqib Iqbal Ahmed
NEW YORK (Reuters) -Investors are on edge ahead of Friday's U.S. jobs report after more evidence of economic resilience cemented expectations of higher rates for longer and sent yields to a 16-year high.
Unexpected strength in the labor market, which showed private payrolls surged in June, sent the two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, to 5.120% on Thursday, the highest since June 2007. Traders in U.S. interest rate futures markets bumped up the probability of another rate increase by the Federal Reserve in November.
"It's counterintuitive, but strong data increases the odds that we will have to go into a recession to break inflation," said Jack McIntyre, a portfolio manager at Brandywine Global.
The S&P 500 Index, fell 0.8% on Thursday, pulling back from a more than 1-year high touched earlier this week.
"We are clearly in a phase where strong data is not good for equities," said McIntyre.
Attention now turns to the June jobs numbers on Friday, which could mark another big move for stocks. The S&P 500 has logged an average move of 1.2%, in either direction, on nonfarm payrolls report days, compared with an average move of 0.9% for all days over the past year.
According to a Reuters survey of economists, nonfarm payrolls likely increased by 225,000 jobs last month after rising 339,000 in May. The unemployment rate is forecast slipping to 3.6% from 3.7% in May.
MOVING MARKETS
Economic data has been an outsized mover of markets in recent months as investors parse each new report for clues on the strength of the U.S. economy.
Many investors are convinced that a hot report on Friday would force the Fed to resume interest rate hikes, jeopardizing a rally in risk assets that has helped lift the S&P 500 about 15% this year.
Federal Reserve Bank of Dallas President Lorie Logan said on Thursday that there was a case for a rate rise at the June policy meeting, in comments that affirmed her view that more rate increases will be needed to cool off a still-strong economy.
RECESSION WATCH
So far the U.S. economy has held up better than many investors had expected. Goldman Sachs (NYSE:GS), in early June, lowered its probability for a U.S. recession in the next 12 months to 25% from 35% and said the Federal Reserve will "most likely" hike interest rates by 25 basis points in July.
But growth expectations could take a hit if the Fed powers on with its rate hikes.
Meanwhile, a closely watched part of the U.S. Treasury yield curve has inverted to its deepest level since 1981, putting a spotlight on what many investors consider a time-honored recession signal.
U.S. interest rate futures on Thursday signaled an increased probability of another rate increase by the Federal Reserve in November.
The benchmark fed funds futures factored in a 44% chance of a hike in November late on Thursday, compared with about 36% the day before, according to CME's FedWatch. For next month's Fed policy meeting, the odds of a 25 basis-point hike were at 92.4%, compared with 90.5% late on Wednesday.
If the jobs report comes in hot it would further stamp out any hopes of equities-supporting interest rate cuts.
"I don't think it causes a major, sustained correction in risk assets if we get a hot number tomorrow," said Aaron Hurd, senior portfolio manager, currency, at State Street (NYSE:STT) Global Advisors.
"But I do think the immediate reaction is yields higher, equities lower," he said.