MW Bonds and the dollar are sounding the alarm about the U.S. economy. Equity investors might want to listen.

By Joseph Adinolfi

Stocks sank on Friday, but the real action was in the bond market

Heading into August, everything seemed to be going right for the U.S. equity market.

Stocks, particularly large-cap indexes like the S&P 500 SPX and Nasdaq Composite COMP, had been perched near record highs. Corporate earnings appeared to have grown at a brisk pace during the second quarter, despite a handful of weak reports that had drawn a swift rebuke from the market. Official data on consumer prices seemed to suggest that, so far, the impact of President Trump's tariffs on inflation had been more modest than expected.

While the pace of economic growth had slowed during the first half of the year, the economy, and the U.S. labor market, remained in good shape. At least, that was what Federal Reserve Chair Jerome Powell suggested during his postmeeting press conference on Wednesday after the central bank had opted to leave interest rates on hold - despite two high-profile dissenting votes.

That sense of calm was shattered on Friday, when the July jobs report showed the U.S. economy created just 73,000 jobs last month. Even more alarming, readings from the prior two months had been revised sharply lower, suggesting that investors' view of the labor market from earlier in the year had been largely a mirage.

See: Bad, terrible, not-so-good July jobs report. Here are the gory details.

The data heaped more pressure on stocks, which were already reeling from the latest round of tariff announcements from the Trump administration late Thursday. Disappointing earnings guidance from Amazon.com Inc. $(AMZN.UK)$ had also weighed on index futures overnight.

By the time the closing bell rang, the Dow Jones Industrial Average DJIA had cemented its worst weekly showing since April, as the blue-chip gauge sank for a fifth straight session on Friday. The Nasdaq Composite fell by 2.2%, snapping a 70-day streak without a decline of 2% or more.

But the real action was in the bond and currency markets. The yield on the 2-year Treasury note BX:TMUBMUSD02Y fell by a staggering 25 basis points to 3.702% based on 3:30 p.m. Eastern Time levels. It was the biggest one-day drop since Aug. 2, 2024. In a single day, the yield on these short-dated notes had erased all of its gains from July.

Bond yields move inversely to prices.

A relief rally in the U.S. dollar was stopped dead in its tracks. The ICE U.S. Dollar Index DXY was off by nearly 1% on Friday, a big move for the world's most-liquid currency.

Strategists at ING speculated that the dollar might have peaked after its best monthly showing since 2022. The U.S. currency has struggled mightily in 2025. At the end of June, it had tallied its worst first-half showing since at least the early 1970s.

As stocks dropped, strategists tried to put the move in context. The S&P 500's technical uptrend remained intact, said Keith Lerner, chief market strategist at Truist Advisory Services, in commentary shared with MarketWatch. After a 28% surge since the April lows, the market was probably overdue for some consolidation. In other words, investors had no need to panic.

But to Richard Farr, chief market strategist at Pivotus Partners, the drop in bond yields and ongoing deterioration in economic data highlighted what he described as a growing disconnect between stocks' lofty valuations and the reality on the ground.

Technical analysis is useful for evaluating a trend, he said. But not for sniffing out a potential inflection points when investors must suddenly face up to reality.

"Stocks are pricing in significant earnings growth, and significant economic growth, yet at the same time, the macro data are deteriorating, and the Fed is doing nothing about it," he told MarketWatch on Friday.

Assuming more weak data follow, investors might find it difficult to reconcile this increasingly dire outlook with stocks' lofty valuations. The cyclically-adjusted price-to-earnings ratio for the S&P 500, better known as the CAPE ratio, had topped 38 in late July, its highest level since 2021.

And the rally in bonds could be just getting started, Farr said. In his view, the yield on the 10-year Treasury note BX:TMUBMUSD10Y could fall to 3.5%, compared with 4.218% on Friday. Whatever happens, investors should keep a close eye on the bond market for clues about where stocks might be headed next.

"This is the first official piece of data that confirms that there is a significant weakening in the job market, and thus the U.S. economy," Farr said. "If that is the case, the robust earnings outlook for stocks needs to be recalibrated."

Further complicating the outlook for stocks is the fact that August and September mark what has historically been the worst two-month stretch for stocks of the entire calendar year.

Investors hoping that the market will shrug off this data and power higher will need to pin their hopes on the Fed acting to aggressively lower borrowing costs in September.

Ross Mayfield, an investment strategist at Baird, said the central bank could justify delivering another 50 basis point cut in September, just like it did at its September meeting last year. Back then, investors had accused the Fed of falling behind the curve. Some even advocated for the Fed to deliver a rare inter-meeting rate cut.

A quick turnaround in the data ultimately helped to vindicate Powell's decision to wait. But Mayfield said he would be surprised if the data were as forgiving this time around, given that the Fed's tight policy stance has had another year to influence the economy.

"It almost feels like that's playing out again," Mayfield told MarketWatch. "Although I do feel like the underlying economy is slightly weaker now because we've had another year of high interest rates, plus these tariffs layered on top."

-Joseph Adinolfi

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(END) Dow Jones Newswires

August 01, 2025 17:03 ET (21:03 GMT)

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