Curious Market Action
Doug Nolan
S&P500 futures were up 0.7% immediately following the release of Friday’s August payrolls data.
Non-farm job gains of 187,000 were marginally above the 170,000 consensus estimate (with July’s gain revised 30k lower).
At 0.2% (0.24%), the increase in Average Hourly Earnings was below the 0.3% forecast and July’s 0.4% - and was the weakest reading since February 2022.
A jump in reentrants boosted the Labor Force Participation Rate two-tenths to a higher-than-expected 62.8% (high since February 2020).
Unexpectedly, the Unemployment Rate increased a market-pleasing three-tenths to 3.8%.
From the perspective of the pundits, the data was close to perfect.
Slowing wage and job growth makes life easier for the Federal Reserve.
No more hikes needed – no tough decisions.
For the markets, data offered further confirmation of the coveted “soft landing.”
Friday morning from Bloomberg: “Goldilocks Is Back as Wall Street’s Jobs-Day Gift.”
Financial Times: “US Jobs Data Raises Hope of Goldilocks Scenario as Economy Cools.”
Real Money: “The Fed Must Be Jumping for Joy After a Goldilocks Jobs Report.”
Jubilant jumping about was short-lived.
The first clue was the 10-year Treasury bond’s muted response to payroll data.
The immediate five bps yield decline had fully reversed within an hour.
Jumps in the ISM Manufacturing Survey’s Employment (48.5 vs. July’s 44.4) and Price (48.4 vs. 42.6) Components didn’t help.
Ten-year Treasury yields ended the session up seven bps to 4.18%.
Bond enthusiasts must feel that life is unfair.
Tuesday’s “JOLTS” job openings data (8.827 million) were much weaker-than-expected, dropping to the lowest level since March 2021.
Conference Board Consumer Confidence was reported 10 points below expectations at 106 (down 8 from July).
The Present Situation component fell eight to a 2023-low 144.8.
ADP’s August job gains were reported Wednesday at a weaker-than-expected 177k (expectations 195k), the fewest jobs added since March.
And a revision to the Q2 GDP Price Index (2.0% vs. 2.2%) reduced second quarter growth to 2.1% (from first reading 2.4%).
For all the weaker data, 10-year bond yields declined a measly six bps this week, with Friday’s closing yield (4.18%) only 16 bps below the 16-year closing high (4.34%) from nine sessions ago (August 21st).
And there are some curious happenings in the bond market.
Bonds are just not seeing much benefit from changes in Fed rate policy expectations.
As of Tuesday, markets saw a 22% probability of a rate hike at the Fed’s September 20th meeting, with an additional 48% for the November 1st meeting.
This 70% probability for one additional Fed increase had sunk to 38% by Friday’s close (7% for September and 31% November).
The rates market says the Fed’s tightening cycle is likely over, yet bonds are conflicted.
It's as if the bond market views the “soft landing” Goldilocks scenario with increasing wariness.
Just not feeling it.
As splendidly as it plays with equites and for the Fed doves, is it constructive for the bond market?
Bonds these days yearn for the good old decades, where everything seemed to go their way.
My take: The so-called “soft landing” will not cut it.
Goldilocks is a myth.
After all, inflationary forces have taken hold throughout the U.S. economy.
It would now require a significant tightening of financial conditions to quash the unfolding inflationary cycle.
Recent tempering of wage gains doesn’t negate the strongest compensation momentum in decades.
Importantly, labor markets remain sufficiently tight to further embolden unions and workers alike.
And especially with the U.S. economy having evolved over recent decades to be services dominant, wage growth today plays a pivotal inflationary role.
For an economy with inflationary dynamics maintaining robust momentum, financial conditions remain too loose.
And at this spirited phase of the Speculative Cycle, risk markets will overreact to data supportive of the bullish narrative.
The Nasdaq100 surged 3.7% this week, boosting 2023 gains to 41.6%.
To be sure, economic resilience owes everything to loose conditions.
Now, economic softening only stokes speculative impulses.
This works to exacerbate loose conditions, underpinning both growth and pricing pressures.
Moreover, market “risk on” ensures strong corporate debt issuance.
September 1 – Bloomberg (Alyce Andres):
“Preparations for an onslaught of corporate supply next week have weighed in Treasuries today…
Banks that underwrite the bonds expect about $120 billion to be issued [this] month, much more than the $78 billion sold in September 2022…
Expectations are for that number to get revised higher as the market is ripe for debt issuance.
That’s because investment-grade credit default swaps fell to an 18-month low this week.”
Corporate risk premiums narrowed further this week.
Investment-grade spreads (to Treasuries) were little changed at 1.19 percentage points (near low since February ‘22), with high yield spreads narrowing 14 bps to 3.66 – the low since April ’22.
Investment-grade CDS traded down to 62 bps in Wednesday trading, just above lows back to February 2022.
High yield CDS dropped 16 this week to 422 bps, trading at about the same level as in April 2022 (as the Fed commenced “tightening”).
That longer-term bonds reacted tepidly to weak data supports the secular new paradigm thesis.
Notably, 30-year long bond Treasury yields were up a basis point this week to 4.30%, even as two-year yields sank 20 bps to 4.87%.
Central bankers are also not oblivious to New Cycle Dynamics.
August 27 – Associated Press (Christopher Rugaber):
“Rising trade barriers.
Aging populations.
A broad transition from carbon-spewing fossil fuels to renewable energy.
The prevalence of such trends across the world could intensify global inflation pressures in the coming years and make it harder for the Federal Reserve and other central banks to meet their inflation targets.
That concern was a theme sounded in several high-profile speeches and economic studies presented Friday and Saturday at the Fed’s annual conference… in Jackson Hole, Wyoming…
‘The new environment sets the stage for larger relative price shocks than we saw before the pandemic,” Christine Lagarde… said… ‘If we face both higher investment needs and greater supply constraints, we are likely to see stronger price pressures in markets like commodities — especially for the metals and minerals that are crucial for green technologies.’”
And perhaps the bond market is not finding recent Chinese developments all that comforting.
So-called Chinese “deflation” (despite $4.25 TN one-year growth in Aggregate Financing!) and ineffectual “piece meal” policy measures have clear potential to evolve into massive fiscal and monetary stimulus.
Increasingly, a desperate Beijing rises each morning to throw new stimulus measures against the wall: policy and lending rate reductions, mortgage rate resets, and various measures to ease apartment buying and borrowing requirements, fiscal stimulus, and policies to boost local government finances and the stock market.
Beijing is also implementing a variety of measures to bolster its frail currency.
August 29 – Bloomberg:
“China is flashing new signs of financial stress almost on a daily basis, with a property giant making fresh efforts to avoid default and a state-run bad debt manager suffering a bond slump on worries about its own health.
In the latest indication of its liquidity struggle, Country Garden Holdings Co. has proposed a grace period of 40 calendar days for a maturing yuan bond as it seeks to win creditor support to stretch payment into 2026.
Meantime, China Great Wall Asset Management Co.’s dollar bonds fell by the most this year Tuesday, as analysts raised concerns over a delay in releasing 2022 earnings.
The ceaseless warning signals from credit markets are adding to broader concerns about the world’s second-largest economy…”
After opening Monday trading up 5% (following Sunday’s stimulus announcements), the Shanghai Composite ended the week with only a 2.3% gain.
It's worth noting that, despite a growing list of stimulus measures, China’s dollar high yield bond index traded this week at 2023 highs (20.31%) – as did the Asian High Yield Index (16.12%).
August 30 – Bloomberg (Harry Suhartono):
“Yield premiums on high-grade Asian dollar bonds were on course for the sharpest monthly jump since March, as concerns about China’s ailing economy and property woes weighed on demand.
The credit spreads have widened by 15 bps so far in August, set for the biggest such move since March…, while the yield premium on dollar notes from Chinese investment-grade issuers increased by 20 bps.
More than two dozen bonds with the biggest spreads blowout are from Chinese borrowers or those with significant exposure to the country.”
Let’s return to Friday’s interesting trading action.
Along with the upward reversal in Treasury yields, the dollar also caught a bid.
After initially trading lower on the payrolls release, the Dollar Index reversed a full percent higher to end the session up 0.6% - reversing the loss from earlier in the week.
Despite weaker data, global markets continue to indicate vulnerability to the rising bond yields and strong dollar scenario.
This development would be problematic for emerging markets, especially in the event of a disorderly decline in the Chinese renminbi.
The final week of the summer did not disappoint the bullish crowd.
Yet the change of seasons is known to bring a shift in market focus.
China is on an ominous trajectory.
It’s unclear how long Beijing can maintain a semblance of control. Global bond markets don’t look out of the woods.
Inflation risks remain elevated.
By this point, the levered players have become so conditioned to disregard risk - more confident than ever in central bank liquidity backstops.
It’s therefore reasonable to assume that risk aversion can be held at bay longer than would typically be the case.
But this only elevates the risk of an eventual major de-risking/deleveraging eruption.
Surging global yields and a China accident provide decent potential catalysts.
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