Morgan Stanley: Strong NFP Does Not Hinder US Stock Prospects; Watch Interest Rate Volatility Risks

Overview

This summary consolidates cross-asset views from Morgan Stanley economists and strategists following the release of the latest non-farm payroll data. The core conclusion is that the US labor market remains resilient, showing no signs of drag from the energy sector, which should alleviate the Fed's concerns about downside employment risks; meanwhile, core inflation is slowing. In this context, as long as the Fed maintains a neutral stance and does not restart rate hikes, moderate inflation is actually beneficial for corporate earnings and stock market performance, particularly for cyclical stocks. Although recent market declines were triggered by position adjustments, institutions remain constructive on the medium-term outlook for US equities. The primary risks lie in excessively high interest rate levels and rising volatility.

Core views

Labor Market and Inflation Dynamics: The latest non-farm payroll report shows enduring economic resilience. The 3-month moving average of new non-farm payrolls reached 188k, with prior values revised upward by 93k, indicating that the labor market is not as weak as some feared and shows no negative drag from the energy sector. Although the unemployment rate remains at 4.3%, if monthly new jobs stay around 100k in the future, the unemployment rate is expected to decline further. Regarding inflation, the core CPI MoM growth slowed to 0.22% (YoY 2.8%), mainly benefiting from softening service inflation; although overall CPI remains at a higher level due to positive commodity prices (MoM 0.56%, YoY 4.3%), tariff effects are fading, and institutions expect near-to-medium term inflation to continue falling. US Equity Strategy and Style Preferences: The strategy team believes that the current macro combination—inflation rising + Fed neutral—is favorable for equity assets, especially cyclical stocks. Historical data shows that in non-recessionary periods with neutral Fed policy and EPS growth above the median, the probability of the S&P 500 index rising is as high as 92%. Although the market experienced significant position-driven selling last week, and the valuation expansion in the semiconductor sector rivals that of the tech bubble era, this technical correction is considered a necessary release. As long as the Fed does not raise rates due to inflation, the market can digest the current inflation level, and strong earnings and macroeconomic data will continue to support broader market participation. Interest Rates, Volatility, and Liquidity Risks: The core constraint in the current market is interest rates. When the 10-year US Treasury yield breaks through 4.5%, stocks and interest rates exhibit extremely strong negative correlation, meaning any upward movement in rates will directly suppress valuations. Furthermore, markets often underestimate the importance of liquidity factors. Financing market pressure indicators (such as the spread between SOFR and the Federal Funds Rate) are key leading signals for judging whether the Fed will intervene via the Repurchase Management Plan (RMP). Institutions believe that the market is currently too fixated on the narrative of 'overheating labor markets,' ignoring details such as narrowing employment breadth and cooling wage growth. These fundamental characteristics do not support a sustained interest rate hike risk premium, so the forecast predicts room for downward movement in US Treasury yields.

Analysis framework

The research report adopts a typical analytical path of 'macroeconomic data verification → policy reaction function deduction → cross-asset pricing transmission.' First, by analyzing the 3-month moving average of non-farm payrolls, the unemployment breakeven point, and CPI component breakdowns, single-month noise is filtered out to identify the true drivers of inflation (e.g., distinguishing one-time tariff shocks from service inflation trends). Second, the macro state is mapped to the Fed's reaction function to determine that under the current combination of 'stable employment + declining core inflation,' the central bank is likely to maintain neutrality rather than tighten. Finally, historical statistical patterns (such as win rates of the S&P 500 under different macro environments) and technical indicators (such as semiconductor index deviation and stock-bond correlation thresholds) are used to assess the safety margin and potential risk points of current asset prices, thereby deriving allocation recommendations.

Methodology notes

• Macroeconomic frameworkPhillips curve

  Analysis of the trade-off relationship between labor market heat and inflation/wage pressures

  By analyzing the phenomenon of strong non-farm payrolls but cooling wage growth and narrowing employment breadth, the report judges that the traditional Phillips curve effect is weakening, i.e., strong employment does not necessarily lead to失控 inflation, thereby deriving the conclusion that the Fed does not need to raise rates.

• Quantitative/Factor/Portfolio TheoryBeta/alpha analysis

  Stock-bond correlation and interest rate sensitivity analysis

  The report points out that when the 10-year US Treasury yield exceeds the critical value of 4.5%, the negative correlation between stocks and interest rates strengthens significantly. This is a conditional Beta analysis, reminding investors that in a high-interest-rate environment, interest rate volatility will become the dominant factor in pricing equity assets.

• Cycle and Prosperity FrameworkProsperity Turning Point Analysis

  Predicting central bank policy intervention turning points based on liquidity pressure indicators

  The report treats financing market pressure (such as the SOFR-FFR spread) as a trigger for Fed liquidity operations. This method does not solely rely on economic data but predicts central bank behavior and its supportive role for risk assets through changes in the microstructure of financial markets.

Key data

• 3-Month Average Non-Farm Payrolls188kShows the labor market remains robust; prior value revised up by 93k
• Unemployment Rate4.3%Remains stable; expected to decline if monthly new jobs average 100k
• Core CPI MoM0.22%YoY 2.8%; softening service inflation drives core metric deceleration
• Overall CPI YoY4.3%MoM 0.56%; supported by commodity prices but still at high levels
• S&P 500 Upside Win Rate92%Historical probability of positive returns when EPS growth exceeds median and Fed environment is neutral
• Rate Negative Correlation Threshold4.5%Strong negative correlation between stocks and bonds when 10-year Treasury yield is above this level

Impact & implications

For the equity market, the current macro environment means that 'bad news' (such as moderate inflation) could turn into 'good news,' provided the Fed holds steady. Cyclical stocks and sectors benefiting from nominal growth may continue to outperform, but investors should remain vigilant about highly valued growth sectors like semiconductors, whose crowding is already at historical extremes. For the fixed income market, since deep indicators such as wages and employment breadth do not support continued tightening, there is a foundation for long-end Treasury yields to fall, and the current interest rate hike risk premium may be overstated. Overall, the main contradiction in the market has shifted from 'recession panic' to 'interest rate volatility tolerance,' with liquidity conditions becoming the key variable determining the upper limit of risk assets in the next phase.

Risks

• 10-year Treasury yields remaining above 4.5% exacerbating stock-bond negative correlation, suppressing equity valuations
• Rising interest rate volatility triggering market deleveraging or position adjustments
• Excessive valuation expansion in popular sectors like semiconductors, facing risks of technical corrections
• If financing market stress is not promptly intervened by the Fed, it may trigger a liquidity shock

What to watch

• Latest comments from Fed officials on labor market details (such as wages and breadth)
• Whether the 10-year Treasury yield continues to hold above 4.5%
• Changes in financing market spreads (SOFR vs FFR) and Fed RMP operation trends
• Sustainability of cooling service inflation in subsequent CPI data