'We don't need recessionary-level cuts from the Fed,' says a senior portfolio manager for fixed income at Morgan Stanley

U.S. stocks rallied Friday on fresh signs of a strong labor market, with the Dow Jones Industrial Average ending at a record peak while the bond market dialed back recession fears.

The U.S. employment report for September was "surprisingly strong," said Vishal Khanduja, senior portfolio manager for fixed income at Morgan Stanley Investment Management, in a phone interview Friday. "We don't need recessionary-level cuts from the Fed," he said, pointing to the latest data on jobs growth spurring the bond market to price out some of the aggressive reductions to the Federal Reserve's policy interest rate that traders were expecting this year.

Treasury rates in the bond market jumped Friday after the Bureau of Labor Statistics released a report showing the U.S. economy added 254,000 jobs in September while the unemployment rate dipped to 4.1%. All three major U.S. stock benchmarks closed higher Friday, eking out weekly gains after stumbling earlier in the week amid heightened worries over the Middle East.

"We are confident" that the U.S. economy is on track for "a soft landing," as opposed to a hard one suggested by the aggressive pace of rate cuts that the bond market recently had been pricing in, said Khanduja.

On Friday, the yield on the 2-year Treasury note BX:TMUBMUSD02Y surged 21.8 basis points to 3.929%, the highest rate since Aug. 26 based on 3 p.m. Eastern time levels, to book its biggest weekly jump since June 2022, according to Dow Jones Market Data.

The 10-year Treasury yield BX:TMUBMUSD10Y climbed 13.1 basis points Friday to 3.980%, the highest rate since Aug. 8 based on 3 p.m. Eastern time levels, seeing its largest weekly climb since last October.

Khanduja said he expects the Fed may lower its benchmark rate two more times this year in quarter-percentage-point increments, after kicking off its rate-cutting cycle last month with a half-point reduction. With inflation trending lower, the Fed is recalibrating its monetary policy, he said.

Investors will get a reading on U.S. inflation in September from the consumer-price index next week, with the CPI report scheduled for release by the Bureau of Labor Statistics on Oct. 10.

Although the Fed has begun cutting rates, they remain elevated, leaving yields in the bond market at still-attractive levels, according to Khanduja. Assuming inflation is tamed, bonds should provide investors both income and diversification, which would help to protect portfolios in times of turmoil, he said.

Meanwhile, investors are monitoring the Middle East, as Israel may retaliate against Iran for its missile attack earlier this week.

See: Biden says Israel should consider 'other alternatives' than striking Iranian oil fields

Check out: Aerospace and defense ETFs beat S&P 500 as Middle East fears intensify

U.S. stocks ended higher Friday, with the Dow DJIA rising 0.8% to notch its 34th record close of the year. The S&P 500 SPX rallied 0.9% and the technology-heavy Nasdaq Composite COMP jumped a sharp 1.2%.

All three indexes booked a fourth straight week of gains after Friday's jobs report, with the S&P 500 edging up o

n the week 0.2% while the Dow and Nasdaq each finished with a slight weekly rise of 0.1%.

The September jobs report "weakens the case for aggressive Fed cuts," said Barclays analysts in a research note Friday. "This report undermines the widely held view that labor demand is losing steam, reinforcing our call for continued resilience in activity and a high likelihood of a soft landing."

The Barclays analysts said they expect the Fed to cut rates by a quarter point at each of its remaining policy meetings this year, in November and December. That's in line with the expectations in the federal-funds futures market, where traders on Friday reflected a higher probability of such a rate path following the stronger-than-expected jobs report.

See: After jobs report, fed-funds futures show higher chance of quarter-point cut in November

"What we are likely witnessing is a moderation in the pace of hiring after a very strong postpandemic rebound," said Rick Rieder, BlackRock's chief investment officer of global fixed income and head of the asset manager's global allocation investment team, in emailed comments Friday.

"We think that the rate descent should continue, but with today's strong data it's more likely that the Fed" will cut rates in quarter-point increments - not the near-term half-point cuts that "the market had been pricing in," said Rieder.