Yesterday was a typical risk-off day in the financial markets. The US treasuries rallied, the yields fell, and the stocks fell as well, as the latest set of economic data from the US showed further weakness.
The latest US ISM data revealed that the slowdown in US services was slower than expected – although services still grew in March, growth in employment and new orders slowed sharper than expected. The trade deficit grew, and the ADP report showed that the US economy added around 145K new private jobs last month, versus around 200K penciled in by analysts.
The soft data spurred the expectation that the Federal Reserve (Fed) could soon be done with the interest rate hikes. The US 2-year yield dipped below the 3.70% level, and the 10-year yield is now below 3.30%. The dollar index hit a fresh 2-month low before rebounding in Asia, and the probability of a 25bp hike for May FOMC meeting is now given around a 50-50 chance when looking at the activity on Fed funds futures.
And if the probability of no rate hike is not much higher, the Fed’s Mester has certainly a finger in it. She said that the Fed should move the rates above 5% this year – come hell or high water – to fight inflation. Her words have also been reinforced by a surprise 50bp hike from the Reserve Bank of New Zealand (RBNZ) earlier this week.
Mind the vol
Today, we don’t have an important data release from the US – as the US decided, for a reason that we don’t know – to release the latest jobs data on Good Friday! The expectation is that the US economy may have added around quarter of a million new nonfarm jobs last month, the unemployment rate is seen steady at a multi-decade low of 3.6% and earnings may have grown slightly stronger on a monthly basis, but slower on a yearly basis.
The combination of a sufficiently weak NFP figure, and a sufficiently weak salaries growth should further cement the idea that the Fed should stop hiking further and let the nearly 500bp hike since last year work its way through the economy, along with some tightening in credit conditions due to the bank stress. If the data is stronger-than-expected, which is not the base case scenario, the pricing of a 25bp hike should slightly improve, but investors won’t run to conclusions before next week’s inflation release.
PS: The fact that the US jobs data – which is the most watched data point in the entire world – is scheduled on Good Friday is disquieting. With many traders from developed economies out of office, many stock markets will be closed. And for those markets that will still be up and running, the trading volumes will be thin, therefore the price action posterior to the data will likely be exacerbated by the lack of volumes.
And the higher the gap between the expectation and the data, the wilder the price action could be.
What to expect?
Soft jobs data from the US will likely send the short-term yields to levels that were tested when the Silicon Valley Bank (SVB) collapsed last month, and the dollar index to a fresh year-to-date low.
Unfortunately for the stock markets, the softer yields will likely not be a catalyzer of a further rally, as the recession fears should weigh on earnings expectations and the latter should weigh on the valuations and outweigh the positive impact of softer yields.
For the S&P500, a downside correction below the 4000 handle, and into the 200-DMA is reasonable.
Unless we see a significant improvement in US inflation, stock traders don’t have a strong foundation to build a sustainable rally on. The economic data is weak, and we don’t know how fast inflation will slow. A consensus of analysts’ expectations on Bloomberg suggests that inflation remained steady in March at around 6% for the headline figure and around 5.5% for the core figure, with a slight improvement on a monthly basis for both figures.
But we know that the downward path in inflation is at risk, now that OPEC is actively fighting the softening oil prices, which will, in the coming months, have a boosting effect on inflation figures.
The barrel of crude oil jumped nearly 30% since the second half of March – as energy traders brushed off the banking stress, and OPEC cut production by more than a million barrels per day.
Good news is that the oil rally must be coming to exhaustion at around the $80/82 range, as the weak economic data and the rising recession worries will likely act as a solid resistance to the post-OPEC rally. Released yesterday, the 3.7-mio-barrel decline in US crude inventories could hardly find buyers above the $80pb level. So, the chances are that the barrel could be returning toward the 50-100-DMA levels, around $75/76 in the short run.
Think long-dated, inflation protected
What’s happening right now – increased appetite for sovereign bonds and decreased appetite for equities due to the rising recession positioning – is exactly what we thought would happen this year.
In this context, one of the most interesting plays could be long positioning in long-dated and inflation protected US papers; they will likely outperform your regular long-dated papers, given that we don’t know when and by how much inflation will ease, but we guess that at the current state of things, most of the treasury selloff is likely done.
