NEW YORK Economic concerns are once again showing up on Wall Street's radar, as worries grow that months of elevated interest rates may be starting to hurt US growth.

For months, investors had been heartened by cooling inflation and gradually slowing employment, believing they bolstered the case for the Federal Reserve (Fed) to begin cutting interest rates.

Now that a September rate cut has come into view following a Fed meeting earlier this week, investors are worried that the central bank may have left rates at restrictive levels for too long, allowing them to take a toll on economic growth.

Evidence of such a shift in thinking came on Thursday, when data showing weakness in the labour market and manufacturing sector sparked a sharp selloff in US equities, with investors dumping everything from chip stocks to industrials while piling into defensive plays. Richly valued tech stocks tumbled, extending losses in the Nasdaq Composite to nearly 8% from a record closing high reached in July.

"The narrative has been that rate cuts are just because inflation is coming closer to the target while everything else remains pretty solid," said Angelo Kourkafas, senior investment strategist at Edward Jones. "But now there are some cracks."

The concerns put a spotlight on upcoming releases - such as Friday's employment data and an inflation report later this month - that could exacerbate worries if they show further signs of weakness.

Next week brings earnings from industrial bellwether Caterpillar and media and entertainment giant Walt Disney, which will give more insight into the health of the consumer and manufacturing, as well as reports from healthcare heavyweights such as weight-loss drugmaker Eli Lilly.

Bets in the futures markets on Thursday suggested growing unease about the economy. Fed fund futures reflected traders pricing in an over 25% chance of a 50-basis point cut at the central bank’s September meeting, double the odds from a day before, according to CME FedWatch. Futures priced a total of 85 basis points in rate cuts in 2024, compared to just over 60 basis points priced in on Wednesday.

"The comfort that (the market) took yesterday in feeling that the Fed was on track for a September rate cut has switched to the reality that there is a lot of time between now and that September meeting," said Yung-Yu Ma, chief investment officer at BMO Wealth Management.

Broader markets also showed signs of unease. The Cboe Volatility index - known as Wall Street’s fear gauge - stands near a three-month high as demand for options protection against a stock market selloff rose. Worries over fresh turmoil in the Middle East also contributed to investor nervousness.

Meanwhile, investors have shown a preference for sectors such as utilities and healthcare - popular options during times of economic uncertainty.

Options data for the Health Care Select Sector SPDR Fund showed the average daily balance between put and call contracts over the last month at its most bullish in about three years, according to a Reuters analysis of Trade Alert data.

Trading in the options on Utilities Select Sector SPDR Fund also shows a pullback in defensive positioning, highlighting traders' expectations for strength for the sector.

The healthcare sector is up 4% in the past month, while utilities are up over 9%. By contrast, the Philadelphia SE Semiconductor index is down 11% in that period amid sharp losses in investor favorites such as Nvidia and Broadcom.

To be sure, some investors said the data could just be an excuse to lock in profits after the market's overall strong run in 2024.

“What you’re seeing now, and you’d probably see it for the next month or two, is some kind of consolidation and sideways price action," said Bill Strazzullo, chief market strategist at Bell Curve Trading. "The bigger picture bull trend is intact."

Investors will have more earnings reports to chew over in the weeks ahead, including Nvidia at the end of the month, while the US presidential race could add to volatility.

"It’s such a fine line because you want just enough economic weakness that the Fed will have to cut rates but not so much that it becomes bad for corporate earnings," said Burns McKinney, a portfolio manager at NFJ. "The Fed has almost been like a surfer riding a wave and trying to time everything just right."

  - Reuters