By Carolyn Cohn and Koh Gui Qing
NEW YORK (Reuters) - A rally in world stocks flagged on Friday, while the U.S. dollar retreated from a 24-year high on the yen, after data that showed the U.S. labor market is starting to loosen failed to allay investor fears about aggressive interest rate hikes from the Federal Reserve.
News that Russia has scrapped a Saturday deadline to resume flows via a major gas supply route to Germany, deepening Europe's difficulties in securing winter fuel, further soured sentiment in the United States ahead of the long Labor Day weekend.
Data showed on Friday that U.S. employers hired more workers than expected in August, but moderate wage growth and a rise in the unemployment rate to 3.7% suggested there could be less pressure on the Federal Reserve to deliver a third 75-basis-point interest rate hike this month.
This initially cheered investors and helped the S&P 500 index zoom up over 1%. But the gains reversed into losses over the day, hounded by concerns that a 75-basis-point rate hike was still in the cards. The S&P 500 and the Dow Jones Industrial Average lost 1.1% each, and the Nasdaq Composite dropped 1.3%.
Softer data is seen as alleviating the need for the Fed to raise rates to aggressively curb inflation, moves which the market worries could bring on a recession.
Indeed, some analysts said the latest jobs data kept alive the debate about whether the Fed will raise interest rates by 50 basis points later this month, or 75 basis points.
"We continue to expect the Fed to hike by 50bp in September and November. This report contained enough good news for the Fed," analysts at Bank of America said in a note to clients.
But hawkish remarks from Secretary of Treasury Janet Yellen on Friday after the jobs data, where she was quoted as saying that U.S. inflation remained too high and that it is the Fed's job to bring it down, dampened the initial euphoria.
Still, European stocks rallied 2% off Thursday's six-week lows, while Britain's FTSE jumped 1.9%.
Rallying stock markets helped the MSCI world equity index climb 0.5%. For the week, however, it is headed for a 2.7% drop, which would mark its third straight week of losses.
Fresh lockdowns in China had earlier fueled concerns about global growth, and high energy costs as a result of the war in Ukraine are weighing on Europe.
"The market is laser-focused on how aggressive the Fed is going to be with its hiking cycle," said Giles Coghlan, chief currency analyst at HYCM, adding that expectations for higher rates have solidified since a speech last week by Fed Chair Jerome Powell at the Jackson Hole central banking conference.
The markets are worried about "China slowing, euro zone recession and a hawkish Fed," he said.
Equity funds recorded the fourth largest weekly outflow of 2022, while bond funds saw investors pull out money for a second straight week, BofA said in a note.
In Europe, fears of a recession are increasing, with a survey showing on Thursday that manufacturing activity across the euro zone declined again last month, as consumers feeling the pinch from a deepening cost of living crisis cut spending.
The dollar, a beneficiary of rising interest rates, hit a fresh 24-year high against the yen at 140.80, triggering a warning by Japan's Finance Minister Shunichi Suzuki of "appropriate" action to curb the volatility. By midday in New York, the yen had pulled back to 140.18.
The dollar index, which measures its performance against a basket of six currencies, was flat at 109.58, after hitting a 20-year high in the previous session.
A pause in the dollar's ascent helped the euro to bounce 0.1% to $0.99575.
In bond markets, the yield on benchmark U.S. two-year notes fell to 3.3955%, after hitting a 14-year high of 3.5510% on Thursday.
The yield on U.S. 10-year bonds fell to 3.1950%.
German 10-year bond yields hovered at 1.520%, near recent two-month highs, as expectations grow of a 75 bps hike next week from the European Central Bank.
"Almost half the euro zone is suffering inflation of over 10%, the pressure on the ECB is mounting," said Martin Moryson, European economist at DWS.
GRAPHIC-Developed markets interest rates (https://graphics.reuters.com/GLOBAL-MARKETS/RATES/jnvwemywzvw/G10widget1.1.gif)
MSCI's broadest index of Asia-Pacific shares outside Japan fell 0.6%, heading for its worst weekly performance since mid-June with a tumble of 3.6%.
Japan's Nikkei was steady and Chinese blue chips dropped 0.5%.
The southwestern Chinese metropolis of Chengdu on Thursday announced a lockdown of its 21.2 million residents, while the technology hub of Shenzhen also rolled out new social distancing rules as more Chinese cities tried to battle recurring COVID-19 outbreaks.
"We maintain the view that China will keep its zero-COVID policy until March 2023, when the (leadership) reshuffle is fully completed, but we now expect a slower pace of easing of the zero-COVID policy after March 2023," analysts at Nomura said.
Oil prices recovered much of their recent losses on expectations that OPEC+ will discuss output cuts at a meeting on Sept. 5, though concern over China's COVID-19 curbs and weak global growth continued to limit gains. [O/R]
Brent crude futures rose 1% to $93.3 a barrel while U.S. West Texas Intermediate (WTI) crude futures were up by 0.6% at $87.14 a barrel.
A softer dollar boosted spot gold, which rose 0.9% to $1,710.00 per ounce. [GOL/]
(Additional reporting by Stella Qiu in Sydney; Editing by Sam Holmes, Christopher Cushing, Tomasz Janowski, Mike Harrison and Jonathan Oatis)