A pair of solid economic readings shook markets on Friday, with stocks closing higher on speculation the U.S. will be able to skirt a recession. Now the flip side to that story is that bond traders ended up being forced to trim their bets on rate cuts in 2024 — sending yields soaring.

All around Wall Street, the prevailing view is: While economic strength makes many investors less apprehensive about a hard landing, it also implies the Federal Reserve might have to hold rates higher for longer. For Treasuries, that means an unwinding of the massive dovish trade that pointed to a Fed pivot as early as March. For equities, jobs and consumer resilience bodes well when it comes to Corporate America.

“Just when you think the economy is finally softening, it continues to show signs of strength,” said Chris Zaccarelli at Independent Advisor Alliance. “We remain bullish on the market because we are bullish on the economy.”

Following a slew of figures underscoring a slowdown on the jobs front, Friday’s jobs report showed an unexpected pickup. Nonfarm payrolls increased 199,000 last month, the unemployment rate fell to 3.7 per cent and monthly wage growth topped estimates. A separate report showed U.S. consumer sentiment rebounded sharply in early December — topping all forecasts — as households dialed back their year-ahead inflation expectations by the most in 22 years.

The S&P 500 saw its sixth straight week of gains — its longest winning streak since November 2019. Wall Street’s “fear gauge” — the VIX — hovered near pre-pandemic levels. US two-year yields jumped 12 basis points to 4.72 per cent. Swap contracts now show a 40 per cent probability of a March rate cut — from over 50 per cent prior to the economic data.

To Callie Cox at eToro, the strong jobs data could be a “heat check for Wall Street” after markets rallied significantly on the rate-cut trade. Hopes have gone a little too far, she noted.

“The U.S. economy continues to perform well,” said John Leiper at Titan Asset Management. “The aggressive decline in U.S. Treasury yields we saw last month, which already looked a little overdone, is going into reverse with bond yields jumping. With markets pricing out rate cuts next year, higher-for-longer is back in vogue.”

Softening inflation and employment data in the past month have convinced investors that the Fed is done raising interest rates and ignited bets that cuts of at least 125 basis points of cuts were in store over the next 12 months. Traders scaled back those wagers to about 110 basis points of easing.

“People saying recession need to have their heads examined,” said Neil Dutta at Renaissance Macro Research.

Traders are preparing for another busy week, with readings for the U.S. consumer price index and retail sales, a compressed schedule of Treasury auctions — and the Fed’s final meeting of the year on the docket.

Fed officials are widely expected to keep borrowing costs at the highest level in two decades on Wednesday. Chair Jerome Powell has repeatedly pushed back against growing bets of rate cuts early next year, stressing that policymakers will move cautiously but retain the option to hike again.

While labour market strength implies fewer rate cuts, investors should applaud the jobs report as it suggests the Fed is delivering a “Goldilocks” scenario of lower inflation without recession — which is the best outcome for risk assets, said Ronald Temple at Lazard.

“The Fed has been stymied by better-than-expected data releases,” said Quincy Krosby at LPL Financial. “As long as inflation continues to edge lower, the Fed will likely remain on hold. But if today’s report is a harbinger of continued consumer spending, the Fed may have to issue a considerably more hawkish message and telegraph that they still cannot declare victory on their campaign to quell inflation.”

Former Treasury Secretary Lawrence Summers said the Fed should hold off on a shift toward lowering interest rates until there’s decisive evidence showing that inflation is back under control or that the economy is entering a slump. While a soft landing, where prices come under control without a recession, is looking “more in play,” it’s not an outcome to be confident about at this point, he added.

To Brian Rose at UBS, given that the market is already pricing in a lot of rate cuts in 2024, the Fed will possibly avoid sounding “overly dovish.”

The Fed is likely to keep policy restrictive until mid-2024 — at which point inflation should have subsided sufficiently to warrant a modest easing cycle, according to Ronald Temple at Lazard.

“While labour market strength implies fewer rate cuts, investors should applaud the report as it suggests the Fed is delivering a ‘goldilocks’ scenario of lower inflation without recession — which is the best outcome for risk assets,” he noted.

A key gauge of stock-market worry will climb in 2024 after tumbling this year to the lowest since before the pandemic struck, and the magnitude depends on the strength of the economy, according to JPMorgan Chase & Co. strategists.

The Cboe Volatility Index will “generally trade higher in 2024 than in 2023, and the extent of the increase depends on the timing and severity of an eventual recession” and potential wider swings that could curb selling of short-term volatility, the bank’s Americas equity derivatives strategists, led by Bram Kaplan, wrote in a note Friday.

Stock markets will suffer in the first quarter of 2024 as a rally in bonds would signal sputtering economic growth, according to Bank of America Corp.’s Michael Hartnett.

The narrative of “lower yields = higher stocks” would flip to “lower yields = lower stocks,” Hartnett wrote.

Sentiment indicators are also no longer supportive of further gains in risk assets, Hartnett said. BofA’s custom bull-and-bear signal surged to 3.8 from 2.7 in the week through Dec. 6, its biggest weekly jump since February 2012. A reading below 2 is generally considered to be a contrarian buy signal.

`Fear Gauge' at Pre-Pandemic Levels | VIX drops to lowest since January 2020

Money-market funds attracted their largest inflows since March, while U.S. equities had an eighth straight week of inflows, BofA said, citing EPFR Global data.

David Bailin, Citi Global Wealth’s chief investment officer and head of investments, says stocks are ripe for further gains in 2024 as inflation trends lower, the economy remains resilient and earnings rebound — increasing the opportunity cost for investors still sitting on the sidelines, clinging to their cash.

“I’m not sure what investors are waiting for,” he said. “The US economy is going to stay strong and, eventually, money-market rates are going to come down, so why are people not buying core 60/40 portfolios?”

Elsewhere, oil rebounded as technical levels provided support and the US sought to refill its Strategic Petroleum Reserve, but still remained on course for the longest weekly losing streak since 2018 on concerns about a global glut.

Corporate Highlights:

• The Apple Inc. executive in charge of product design for the iPhone and smartwatch is stepping down, bringing a shake-up to the company’s most critical product lines.
• Endeavor Energy, the largest closely-held oil and gas company in the Permian basin, is exploring a sale that could value it between $25 billion and $30 billion, according to Reuters.
• Honeywell International Inc. agreed to acquire the security business of Carrier Global Corp. for an enterprise value of about $5 billion, which marks the biggest deal since 2015 for the maker of jet engines and gas detectors.
• Starbucks Corp. said it reached out to the union representing hundreds of its stores, a potential step toward ending an impasse that has frayed the coffee giant’s relationship with some of its frontline employees.
• Alphabet Inc.’s Google said that the European Union’s threat to break up its profitable ad tech arm was “flawed” as it formally took aim at the bloc’s allegations of anticompetitive conduct.
• Broadcom Inc., a chip supplier for Apple Inc. and other big tech companies, expects the rapid expansion of artificial intelligence computing to help offset its worst slowdown since 2020.
• Lululemon Athletica Inc.’s fourth-quarter revenue guidance trailed Wall Street estimates, a rare miss for the retailer whose performance routinely exceeds investor expectations.
• Microsoft Corp. and OpenAI Inc.’s partnership, which recently went through a governance meltdown, is facing yet more scrutiny after the UK antitrust watchdog said it’s considering if it should be called in for a full blown investigation.
• Commodity trading giant Trafigura Group paid $5.9 billion in annual dividends to its employee shareholders, more than triple a year earlier, after churning out another record profit in the 12 months through September.
• Anglo American Plc unveiled plans to drastically cut production in a bid to reduce costs amid logistical and operational snarls.

Some of the main moves in markets:

Stocks

• The S&P 500 rose 0.4 per cent as of 4 p.m. New York time
• The Nasdaq 100 rose 0.4 per cent
• The Dow Jones Industrial Average rose 0.4 per cent
• The MSCI World index rose 0.3 per cent

Currencies

• The Bloomberg Dollar Spot Index rose 0.2 per cent
• The euro fell 0.3 per cent to $1.0764
• The British pound fell 0.4 per cent to $1.2548
• The Japanese yen fell 0.6 per cent to 144.99 per dollar

Cryptocurrencies

• Bitcoin rose 2.3 per cent to $44,379.44
• Ether fell 0.2 per cent to $2,364.96

Bonds

• The yield on 10-year Treasuries advanced eight basis points to 4.23 per cent
• Germany’s 10-year yield advanced nine basis points to 2.28 per cent
• Britain’s 10-year yield advanced seven basis points to 4.04 per cent

Commodities

• West Texas Intermediate crude rose 2.7 per cent to $71.20 a barrel
• Spot gold fell 1.3 per cent to $2,002.83 an ounce

This story was produced with the assistance of Bloomberg Automation.