Stocks and Bonds Stumble on Hot Jobs Report. Are Markets in Trouble, or Is It Just Noise?

Good news is again bad news. Investors got an unwelcome surprise on Friday from a hotter-than-expected jobs report, which sent stocks and bonds lower. Investors took the evidence of a robust and healthy labor market as fodder for an extended pause in rate cuts from the Federal Reserve—a scenario that tends to disappoint markets.

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“The stock market has to decide if it wants a strong economy or lower rates, but it can’t have both,” says Steve Sosnick, chief strategist at Interactive Brokers. “Today, we got a strong economy.”

The Morningstar US Market Index was down 1.5% as of midday. Stocks fell across sectors and the capitalization spectrum.

Meanwhile, the yield on the 10-year Treasury note rose as high as 4.79% as the bond market digested the news, adding momentum to a selloff in fixed income that began earlier this week. With its latest move higher, the yield on the 10-year is at its highest level since October 2023.

How Did Markets React to the Jobs Report?

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The SPDR S&P 500 ETF Trust SPY and the iShares Russell 1000 ETF IWB were down 1.8% by midday, with the Invesco QQQ Trust QQQ down by 2.1%. Ten of the 11 SPDR sector ETFs were down, with only the Energy Select Sector SPDR ETF XLE up by 0.5% as natural gas and oil prices climbed. The worst-hit sector was financials, with the Financial Select Sector SPDR ETF XLF falling 2.7%, followed by the 2.6% drop of the Technology Select SPDR ETF XLK and the 2.3% slide for the Real Estate Sector SPDR ETF XLRE.

Bank stocks were among the hardest hit, with the SPDR S&P Bank ETF KBE falling by 3.8% and the SPDR S&P Regional Banking ETF by 4.0%. The Invesco Solar ETF TAN also fell by 3.3%, as the report likely means interest rates will stay higher for longer, hurting the rate-sensitive industry. Small caps fell more than larger stocks, with the iShares Russell 2000 ETF IWM down 2.7%.

What Does the Job Report Mean for Stocks?

While some of Friday’s stumble can be chalked up to a kneejerk reaction to the first economic surprise of the year, analysts say the move also reflects the more durable headwinds at play in the markets: stubborn inflationary pressures and the potential for interest rates to stay stuck at current levels. “Over the long term, it’s getting a little more worrying with the inflation figures,” says Lara Castleton, US head of portfolio construction and strategy at Janus Henderson Investors.

Stubborn inflation means the Fed may have to maintain more restrictive policy, and an increasingly uncertain rate outlook helps explain why markets reacted so strongly to Friday’s data, according to Dominic Pappalardo, chief multi-asset strategist for Morningstar Investment Management. On the other side of the equation, a strong labor market gives the Fed more room to leave rates higher for longer.

Against that backdrop, Castleton expects equity investors to turn away from the broadening trade that began gaining steam last summer and look instead toward safer bets on growth, like mega-cap tech. With rates high, valuations stretched, and growth holding up, Castleton says investors could seek quality within the reliable stocks of the “Magnificent Seven,” which have driven the lion’s share of market returns for the better part of two years and aren’t as sensitive to changes in the rate landscape.

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“For a long time, the broadening trade has depended on rates coming down,” she says. She thinks beneficiaries of that trade (like small caps, which tend to carry a lot of floating rate debt) “just need lower rates” to improve their balance sheets and valuations. That lower-rate regime looks further away than it once did.

What Does the Jobs Report Mean for Bonds?

Treasury bond yields rose following the jobs report as prices fell, most notably among shorter-term bonds, which are more closely tied to Fed policy. Bond traders see the central bank putting rate cuts on hold not just for January but until June.

“It certainly makes the Fed’s hawkish pivot in December look quite prescient,” says Daniel Siluk, head of global short duration and liquidity at Janus Henderson and portfolio manager of the $2.3 billion Janus Henderson Short Duration Inc ETF VNLA. “Yields will remain higher for longer.”

Siluk adds that while shorter-term Treasury yields will remain within a narrower range, longer-term ones will be more volatile, with the 10-year yield ending the year anywhere between 4.25% and 5.50%, with a bias toward the higher end. He says a major factor influencing where bond yields end up will be the policies of the incoming Trump administration.

Investors Should Brace for Volatility

In the grand scheme of market history, Sosnick says intraday stock moves of 1% or 2% aren’t all that concerning. But they may surprise investors, given how rare they’ve been over the past two years. “We got very used to a market that showed low volatility and a strong directional trend,” he says. “The last few weeks, that hasn’t been the case. We’ve seen higher volatility and a fairly choppy market.”

Sosnick stresses that a bumpier stock market doesn’t mean investors should change their outlooks. “But if you’ve been expecting smooth sailing to continue,” he explains, “at least in the short term, you’ve got to be a little more vigilant.”