US stocks edged higher on Thursday, with the Nasdaq Composite rising 0.5% and the S&P 500 gaining 0.4%, as a batch of softer economic data cooled traders' expectations for another Federal Reserve rate hike in October. The move came alongside a drop in Treasury yields, with the two-year yield falling to 4.80% and the 10-year yield slipping to 5.24%.
The catalyst was a run of data that painted a slightly less "too hot" picture of the economy. The ISM manufacturing index came in a touch below forecasts, and S&P Global's own measure was revised lower as well. On the jobs front, weekly unemployment claims remained low and layoff announcements fell, but the numbers didn't scream re-acceleration.
Put together, markets marked down the probability that the Fed raises rates again soon. According to the CME FedWatch tool, the implied odds of an October hike dropped to 34% from 69% just a week earlier. That's a significant shift in sentiment, and it ripples through everything from bond yields to stock valuations.
Why yields matter for your portfolio
When traders cut the implied odds of a rate hike, they're pricing in a lower path for short-term interest rates. That tends to pull down yields, and those yields act like the "discount rate" used to translate future corporate profits into today's stock prices. Lower discount rates make future earnings worth more in present-value terms, which is why stocks often get a boost when yields fall.
The effect isn't uniform across the market. Companies whose profits are expected further in the future are more sensitive to changes in that discount rate. That's why a dip in front-end yields, like the two-year falling to 4.80%, often gives a relatively bigger lift to rate-sensitive, long-duration parts of the market. It helps explain why the Nasdaq, packed with growth and tech names, outpaced the broader S&P 500 on Thursday.
This dynamic has been playing out for weeks, as investors have watched Treasury yields climb to multi-year highs, pressuring stocks. Thursday's reversal offered some relief, but the underlying tension remains.
What's driving the data
The manufacturing sector has been a key focus for investors trying to gauge the economy's trajectory. The ISM index, a widely watched gauge of factory activity, came in slightly below expectations, suggesting that the sector isn't overheating. S&P Global's purchasing managers' index was also revised lower, reinforcing that picture.
On the labor market, weekly unemployment claims stayed low, indicating that layoffs remain limited. Meanwhile, announced job cuts fell, but the overall tone was more subdued than in recent months. For the Fed, which has been trying to cool the economy to bring down inflation, these numbers suggest that the labor market may be loosening just enough to ease pressure for another hike.
Still, the inflation story is far from over. Oil prices have been climbing, and that's a reminder that energy costs can feed through to consumer prices. Even as rate fears eased for the day, the persistence of high oil prices keeps the Fed's inflation fight in the spotlight.
What it means for investors
For everyday investors, the key takeaway is that market expectations for Fed policy can shift quickly, and those shifts have real consequences for portfolios. A 34% probability of an October hike is still meaningful—it's not a done deal, and the Fed could still surprise. But the drop from 69% a week ago shows how sensitive markets are to incoming data.
When yields fall, growth stocks tend to benefit more than value stocks, as we saw Thursday. But that also means they're more vulnerable if yields reverse course. Investors with diversified portfolios should be prepared for continued volatility as the market reacts to each new data point.
The broader backdrop remains one of elevated uncertainty. US yields have been climbing relative to other countries, which has strengthened the dollar and put pressure on global markets. And European stocks have been sliding as energy costs and bond yields bite.
For now, the market is taking some comfort in the idea that the Fed might not need to hike again. But with oil prices elevated and inflation still above target, the path forward is far from clear. Investors should keep an eye on upcoming economic releases and Fed commentary for clues about what comes next.
