Dow, S&P 500 hit all-time highs, but labor market concerns linger

Major stock indexes surged to all-time highs Thursday in the wake of the Federal Reserve’s announcement that it was lowering interest rates by half a percentage point.

The Dow Jones Industrial Average closed more than 500 points higher, up 1.3% on the day,

The S&P 500, the broadest index of publicly traded companies, added 1.7% and also touched new highs. The tech-heavy Nasdaq rose more than 2.5%, and the Russell 2000 index of smaller companies added 2.1%.

The Fed’s cut was widely expected, but it came in larger than many analysts were forecasting. At a news conference announcing the decision, Fed Chair Jerome Powell said that the U.S. economy “is in a good place” and that by cutting rates, the Fed wanted to “keep it there.”

“The economy is growing at a solid pace,” he said. “Inflation is coming down closer to our 2% objective over time. And the labor market is still in solid shape. So our intention is really to maintain the strength that we currently see in the U.S. economy.”

For the moment, markets believe there is enough pent-up demand that by lowering its key fed funds rate, which serves as a benchmark for borrowing rates in the rest of the economy, the Fed can spur businesses and consumers to increase purchases and investments, which in turn would translate into increased hiring.

Steve Sosnick, chief strategist at Interactive Brokers financial group, said in an email that traders are thus far convinced that the Fed's impulse will be to make financial conditions less restrictive, meaning it will be more inclined to take measures that stimulate the economy given lower risk of inflation.

"This rally feels like a bit of a sugar rush, but the longer and further that it persists, the more lasting it seems," he said.

It’s already playing out in the homebuying market, where mortgage applications have risen for four consecutive weeks and six of the last seven as mortgage rates fell to their lowest level in two years — about 6.2% — in anticipation of the Fed’s move.

“The continued decline in mortgage rates is giving the mortgage market a much-needed boost,” Bob Broeksmit, the president and CEO of the Mortgage Bankers Association, said in a statement.

At the same time, a growing set of indicators suggest economic growth may have begun heading in the wrong direction.

While the unemployment rate ticked down in August to 4.2%, it has climbed in four of the last five months, a pace that often precedes recessions. Layoffs remain subdued — and Thursday, weekly jobless claims came in lower than expected — but hiring has slowed dramatically, especially for many white-collar occupations.

The Fed itself believes unemployment may climb higher from here: In its latest Summary of Economic Projections, a majority of Fed officials indicated a greater risk and some uncertainty about rising joblessness going forward.

“The Fed has signaled a high sensitivity to labor-market weakness,” Nomura Holdings financial group said in a note to clients Thursday.

Other Wall Street analysts said that, going forward, more weaker-than-expected jobs data is likely to push the Fed toward another half-percentage-point cut, which is more than where official forecasts currently stand.

The next report on U.S. employment will be released Oct. 4.

While Powell described the risks of more inflation versus more unemployment as balanced, Bank of America economists said in a note published after Wednesday’s announcement that “we think they are more concerned about downside risks to the labor market than upside risks to inflation. That raises the risk that today’s [half-point] cut will not be a one and done.”

In other words, interest rates will have to fall further — and faster — to continue to support overall demand in the economy.