A shrinking service economy and rising jobless claims send stocks to record highs ahead of July 4 holiday

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Wall Street traders sent stocks higher and bonds yields fell as a string of weaker-than-estimated economic reports reinforced the case for the Federal Reserve to start cutting rates this year.

In a shortened session ahead of the US holiday, the S&P 500 headed toward a fresh record on bets policy easing will keep fueling Corporate America. Treasuries climbed as data showed US services sector contracted at the fastest pace in four years, private payrolls rose at a moderate pace and continuing jobless claims climbed for a ninth straight week.

Traders will get further insight into the state of the labor market Friday with the release of the June employment report. Economists anticipate a 190,000 gain in nonfarm payrolls — a step-down from the previous month.

“If the data cooperate, we believe a September cut remains very much in play,” said Win Thin and Elias Haddad at Brown Brothers Harriman & Co.

Treasury 10-year yields fell nine basis points to 4.34%. Swap traders are projecting almost two rate cuts in 2024, with the first in November — though bets on a September reduction increased. The dollar headed toward its biggest drop since mid-May. 

The S&P 500 rose to around 5,520. Tesla Inc. extended its rally into a seventh straight session. Amazon.com Inc. fell. The stock market closes at 1 p.m. New York time Wednesday, while the recommended close for Treasuries is 2 p.m. — when the latest Fed minutes will be released. 

“The bulls are facing little opposition, as most of the pessimists have capitulated, and seasonality and fund flows provide a tailwind,” said Mark Hackett at Nationwide. “Clouds are developing in the macro picture, most notably in consumer data, but the glass-half-full mindset of investors continues to drive markets higher.”

Fed Chair Jerome Powell said this week the latest economic data suggest inflation is getting back on a downward path, but emphasized officials need more evidence before lowering interest rates. When he was asked what keeps him up at night, he pointed to the delicate balance between taming inflation and avoiding a significant deterioration in the labor market.

“Until employment weakens significantly there remains a fundamental support for the US economy, though there is some evidence of slowing,” said Don Rissmiller at Strategas. “Fed members have indicated they want to see more progress on inflation – fortunately the US economy still looks robust enough currently to take an extended rate pause. But the clock is ticking.”

Meantime, Fed Bank of New York President John Williams, who has deeply researched the natural rate of interest known as r-star, pushed back against recent commentary that it has risen since the pandemic.

The idea of a long-run natural rate of interest, which prevails when the economy is not responding to shocks and is growing at its potential, is central to monetary policy but cannot be directly observed. Officials aim to raise rates above the neutral level to cool the economy and fight inflation.

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