Huge Reversal in Bonds and Rally in Stocks Cap Wild Week for Markets

Stocks and bonds rallied on Friday, extending a sharp reversal after fresh data about the health of the U.S. labor market capped a tumultuous week for investors.

The 10-year government bond yield, which underpin rates on everything from mortgages to business loans, dropped more than 0.1 percentage points on Friday, another large decline for a market in which daily moves are often measured in hundredths of a point. Yields move inversely to prices.

A new report showed that the U.S. economy added fewer-than-expected jobs in October, a sign of a cooling labor market that could reduce the need for the Federal Reserve to raise its key rate again as it aims to slow the economy to fight inflation.

That helped to lift the stock market, which had sold off as rates rose in recent months. The S&P 500 was set to end the week almost 6 percent higher, on course for its best week of the year.

The Fed started raising its key short-term rate in March last year, but investors more recently had become fixated on longer-dated market rates, which are driven by a variety of factors like economic growth and inflation expectations, not just the Fed’s policy decisions. These long-term rates began surging in August, intensifying concerns about the sustainability of the government’s $33 trillion debt pile, among other worries.

Those concerns dissipated somewhat this week. Investors welcomed plans from the Treasury Department to skew its borrowing toward shorter-term debt, taking pressure off longer-dated yields. Then, Jerome H. Powell, the Fed chair, appeared to soothe investors’ nerves after the central bank held rates steady for a second consecutive meeting. Weaker-than-expected job growth further suggested that the Fed’s efforts to slow the economy were having an effect.

“To me, the jobs report is an unquestionable positive,” said Ronald Temple, chief market strategist at Lazard. “I think it’s a really good signal to the Fed that they are slowing the economy and that they don’t need to raise rates again.”

The 10-year Treasury yield is on course to end the week at around 4.5 percent, down roughly 0.3 percentage points for the week, its largest drop since the week the cryptocurrency exchange FTX collapsed last year. Still, the yield remains more than half a percentage point higher than it was at the start of August.

This week’s dip in yields set off a broad rally across stock markets. The Russell 2000 index of smaller companies, which are more sensitive to the ebb and flow of the economy, rose nearly 3 percent on Friday. That index had fallen over 18 percent in recent months.

Some investors warned that the market reaction might not reflect such a rosy story. The unemployment rate ticked up to 3.9 percent in October, from 3.8 percent the previous month, while the number of people working or actively looking for work nudged lower.

“What concerns me is when we see such an increase in the unemployment rate, it tends to trend higher,” said Blerina Uruci, chief U.S. economist at T. Rowe Price. “That’s what I’m monitoring closely. Otherwise, the slowdown in employment looks orderly.”

After the jobs report, investors have dialed down the likelihood of the Fed raising interest rates at its next meeting, in December, and brought forward expectations of rate cuts next year, a sign that they believe the Fed is done increasing rates and that the economy will continue to slow.

Mr. Powell, the Fed chair, said on Wednesday that the recent increase in long-term interest rates, which raises borrowing costs and slows the economy, effectively doing the Fed’s job for it, would need to be “persistent” for it to play a role in convincing policymakers not to raise their key policy rate again.

But if the recent reversal in the bond market persists and yields continue to fall, then “ironically” it could make the Fed more likely to raise its rate in December, said Mark Dowding, chief investment officer at the asset manager BlueBay, because it will lower borrowing costs and ease the brakes on the economy.

And while a slowing economy would be expected to lower longer-term rates over time, worries over who will buy the deluge of debt the U.S. government is set to issue could push rates in the opposite direction.

“There are two opposite forces at work,” said Paul Christopher, head of global investment strategy at the Wells Fargo Investment Institute. “One is the slowing economy, which is entrenched now and that will bring yields down. But over time, the Treasury will issue more debt and those yields will go back up again. We are in a cross-current right now.”

Jeanna Smialek contributed reporting.