AI buildout, renewed data stream frame market action

Labor market cooling, but Fed still has room to cut

The end of the longest U.S. government shutdown in history allows the release of backlogged economic data. Central to our current risk-on stance is a cooling labor market giving the Federal Reserve room to cut rates. Alternative datasets suggest the labor market is still in a “no hiring, no firing” stasis – and we look for the resumption of U.S. payroll releases to confirm that backdrop. Our pro-risk stance is tilted toward U.S. stocks and AI – making Nvidia’s earnings this week a key input.

Solid U.S. corporate earnings and expected Federal Reserve policy rate cuts have buoyed equities during the past two months, even amid no economic data and brief pullbacks. Alternative data, including state-level jobless claims, suggest that the U.S. labor market is cooling but not deteriorating – reflecting a “no hiring, no firing” stasis that supports the Fed’s ability to keep cutting rates (see the chart below).

Private payrolls data from ADP showed recent job gains are soft but still positive. ADP’s reading is a less reliable indicator on its own – but can still serve as a rough signal of broader trends. The reopened U.S. federal government will release the September jobs report on Thursday, but some of the October data may not arrive at all – making it the first missing month in seven decades.

If there is no October CPI release, the next inflation update is unlikely to arrive until mid-December. We may see October establishment survey results, used to determine payroll changes, but not the household survey that shapes the unemployment rate. The October jobs report – if released – will likely show a sharp drop in payrolls due to deferred government layoffs from earlier this year. That may dominate the headlines, but we think the Fed has factored that in and will stay focused on a risk management approach to a cooling labor market – keeping a December rate cut in play. Markets are pricing in roughly a 40% chance of a quarter-point cut next month, down from a near certainty before last month’s Fed meeting.

The evolving AI theme

Our current pro-risk stance is based on the Fed cutting rates and the AI theme. We stay nimble and watch key signposts including this week’s quarterly results and forecasts from Nvidia – the AI bellwether company producing GPUs is key to the AI buildout. Mega cap tech “hyperscalers” upped their AI capital spending plans in third-quarter earnings – and are now issuing debt to fund these plans.

We see the AI theme evolving as it becomes more capital heavy. Even as AI stocks have wobbled in recent weeks on worries about market froth and the debt financing, we think this is a necessary step in the AI buildout. The dominant AI names reported strong third-quarter earnings and forecasts. That earnings strength has broadened, even as “magnificent seven” earnings, excluding Nvidia, jumped 27% in the third quarter, double expectations, according to LSEG Datastream data. The rest of the S&P 500 saw earnings surge to 14%, well above expectations for 8% at the start of the quarter.

We see a growing divergence between the U.S. and Europe in earnings. European earnings have also beat with a 6% gain compared with expectations for a flat outcome – but for the full year European earnings have contracted. Lagging earnings have kept us neutral on European stocks, and we’ve only seen more signs of soft growth for the region as structural constraints, such as low productivity, persist. We prefer select European sectors such as financials and industrials.

Our bottom line

The reopening of the federal government provides key macro data we’ve been lacking. We’re looking for confirmation of a soft labor market allowing the Fed to cut rates, which underpins our pro-risk stance.

Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.

Wei Li, Global Chief Investment Strategist, Blackrock Investment Institute at BlackRock Inc., Glenn Purves, Global Head of Macro – BlackRock Investment Institute, and Nicholas Fawcett, Senior Economist – BlackRock Investment Institute, contributed to this article.

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