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The past week's U.S. stock market has been a rollercoaster ride, with the initial unwinding of carry trades, recession fears, and speculation about an emergency Fed meeting almost dissipating as two service industry and employment data points, representing the resilience of the economy, stabilized. The expectation of a soft landing has also reignited, causing the pricing of Fed easing to retreat, with the CBOE Volatility Index (VIX) falling from its yearly high to near its long-term average.

However, as the earnings season approaches its end, investors are paying increasing attention to the performance of economic data, and any potential negative news could become the catalyst for a new round of selling.

Fed Easing Expectations Cool Down

After the unexpected negative non-farm payrolls in July, the two most important data points last week did not bring any more "surprises" to the market.

Data from the U.S. Department of Labor showed that for the week ending August 3, initial jobless claims decreased by 17,000 to 233,000, marking the largest drop in nearly a year. This indicates that the U.S. labor market is still stable. The Institute for Supply Management (ISM) reported that the U.S. service sector activity index rose from 48.8 in June to 51.4 in July, significantly better than market expectations and bringing the index back above the 50 threshold.

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Bob Schwartz, a senior economist at Oxford Economics, told First Financial Journal that the labor market conditions have softened compared to the beginning of the year, ensuring that the Fed will cut rates in September and increasing the likelihood of a more aggressive policy shift. However, there are signs that the rise in the unemployment rate in July exaggerated the degree of loosening in the job market.

On the other hand, Schwartz finds the details of the ISM report encouraging, with a clear rebound in business activity, new orders, and employment in July. However, he cautions against overreacting to one month's data and instead advises focusing on trends. From the current situation, the expansion of the U.S. service sector is still far above the level consistent with an economic recession.

Facing pressure for an emergency rate cut, Fed officials continue to emphasize the consideration of easing policies and will learn more from economic data. Boston Fed President Collins stated that if economic data continue to develop as expected, it may be appropriate to begin easing monetary policy soon. "With a healthy labor market, my outlook is to continue gradually reducing to the 2% (inflation) target," he said. Kansas City Fed President Schmid stated that U.S. inflation is cooling, laying the groundwork for a Fed rate cut, "but we have not fully reached the target," he said.

Changes in interest rate expectations have caused a significant shock in U.S. Treasury yields. The 2-year U.S. Treasury note rose 18.2 basis points to 4.05% for the week, and the benchmark 10-year U.S. Treasury note rose 14.8 basis points to 3.94%, which was close to 3.70% at the beginning of the week due to speculation about a 50 basis point emergency rate cut by the Fed. According to the CME Group's FedWatch tool, the probability of a 50 basis point rate cut by the Fed in September is similar to a 25 basis point cut, which was close to 80% last weekend.

Michael Gapen, U.S. economist at Bank of America Securities, believes that as concerns about the risk of a hard landing stabilize and the U.S. labor market does not roll over, the data will show us what kind of economy we have: one that is slowing down gradually or one that is slowing down sharply.Schwartz told Yicai that even with favorable employment and service industry news, he believes that the trend of economic slowdown in the United States in the second half of the year under the pressure of restrictive policies cannot be changed, but there are no signs of it being destructive. It can be seen that the outside world also realizes that the previous expectations of a significant interest rate cut in September were a bit excessive, and the traditional 25 basis point model may be the first step. Now it is necessary to continue to pay attention to the subsequent economic data and Powell's speech at the Jackson Hole conference.

Volatility risks still need to be vigilant.

The new round of adjustments in the U.S. stock market that began in late July has not yet ended, and both the S&P 500 and the Nasdaq indexes have fallen for the fourth consecutive week.

Although the decline in the past week has narrowed significantly compared to before, looking at the VIX trend which measures market volatility, the panic sentiment is unprecedented in the past three years. The S&P 500 index fell 3% at the opening on Monday, setting the largest single-day decline since 2022, and the Dow Jones index once fell more than 1,200 points. Subsequently, strong employment data attracted bottom-fishing funds to re-enter the market, and the originally high recession concerns were effectively released, and the VIX also fell nearly two-thirds from the high at the end of the day.

UBS Wealth Management Senior Vice President Jackson (Christopher Jackson) said: "Overall, we are still in an environment of economic slowdown (if not stagnation), and inflation is declining, which does not mean a recession at all. I believe that the U.S. economy will still grow in the future, just not as fast as last year."

After the unwinding of the yen carry trade and the release of recession pressures, the previously hard-hit industries have rebounded. However, the storm is far from over, and the AI leader Nvidia is still in a bear market area. At the same time, the pressure of industry regulation is increasing. When Google was found to have a monopoly in the online search market and faced penalties, British antitrust officials are investigating whether Amazon's billions of dollars of investment in AI company Anthropic poses a threat to competition. This is the latest attempt by European regulators to compete with U.S. tech giants.

U.S. Bancorp Wealth Management's Chief Equity Strategist Sandven (Terry Sandven) said: "The fundamental background is still conducive to the rise of the stock market, especially for investors who focus on the end of the year and longer periods. In the short term, the increase in market volatility may become the norm rather than the exception, because the valuation of the market is still very high, and seasonal trends indicate that during the summer, when the U.S. stock market is sluggish, the return on the stock market will decrease."

Charles Schwab wrote in its market outlook that the recent stock market volatility is mainly due to two factors. The first is the impact of the Bank of Japan's interest rate hike on carry trades, and the second is the increased probability of a U.S. economic recession. For bulls, the good news is that Bank of Japan Deputy Governor Naohiko Ueda said that the central bank will not raise interest rates when financial markets are unstable, which has eased the momentum of the yen's appreciation. However, the United States has indeed triggered several recession indicators: such as the inversion of the yield curve and the Sam rule. Considering that the forward price-earnings ratio of the S&P 500 index is about 21 times, this is not the level corresponding to a recession, which helps to explain why the market has been tense recently.

The institution believes that considering the current seasonal bearish and the market's sensitivity to economic data, volatility in the coming weeks may increase. Speaking of economic data, the upcoming July CPI and PPI, retail sales, and initial jobless claims indicators may be subject to more scrutiny. Overall, the market is recovering from panic selling, but the process will not be smooth. For investors, any negative economic abnormal data may cause the momentum to turn back to the bear market again.