The excellent combination of lower than expected US NFP, weaker than expected wage growth and the unemployment rate at a near two year high sent another wave of optimism through the financial markets on Friday that the Federal Reserve (Fed) is done raising interest rates.
What’s more, a combined 100,000 downward revision to the August and September numbers suggested that late summer job creation wasn’t as strong as previously reported. All the key metrics now suggest that the US labor market is cooling and that the Fed’s aggressive tightening campaign is finally having the expected easing effect. This should help keep inflation on track for further easing to the Fed’s 2% target. And with a bit of luck, without pushing the US economy into recession.
As a result, the Fed is now expected to start cutting rates by June, with a 100bp cut by the end of next year. Combined with early optimism that the US Treasury will borrow less this quarter than previously thought, the US bond market is on fire. The US 2-year yield fell to 4.85% last Friday, the 10-year yield briefly dipped below 4.50%, and the 30-year dipped below 4.70%.
All of this is great, but if the bond markets decide to move faster than the music, US financial conditions would be eased too fast, too soon, and the Fed would return to a hawkish stance. Therefore, the rally in the US bond market is likely to slow down a bit this week.
Risk rally
After three months of struggle, US equities roared back. The S&P500 jumped nearly 6% last week, its best week since the beginning of the year. The VIX index dropped below the 15 level, and the US dollar fell the most since July, sinking below its 50 DMA and triggering a nice rally in the major pairs. The EURUSD flirted with 1.0750 even as European economies stagnated and inflation fell to a 2-year low, giving the doves at the European Central Bank (ECB) plenty of reason to remain confident about the end of the hiking cycle in the Eurozone.
Cable rallied to the 1.2390 level, even though the Bank of England‘s (BoE) forecasts, released the day before the US jobs data, didn’t paint a sunny picture for the British economy. The USDJPY fell below the 150 level as the U.S. employment data came to the rescue of the desperate Japanese Yen, which was hit hard by another dovish policy announcement from the Bank of Japan (BoJ) two weeks ago, and the AUDUSD jumped to its 100 DMA and could extend the rally if, As expected, the Reserve Bank of Australia (RBA) hiked interest rates by 25 basis points tomorrow for the first time in 5 months and said that interest rates will remain high for a year to bring inflation to target, which may not be easy given the continued strength of the economy and ultra-low unemployment.
What’s going on with oil?
In summary, bonds are up, yields are down, stocks are up, the US dollar is down, and the major currencies are up as a result of a broad-based rally in the US bond market. But interestingly, there’s one kid in the party room that’s less happy than the others, and that’s crude oil.
Normally one would’ve expected the dovish Fed expectations, the lower dollar and a global risk rally to boost sentiment in oil. However, crude oil remained under pressure on Friday, testing $80 on the downside. Rising tensions in Gaza, news that Israel has encircled Gaza City, and headlines that Saudi Arabia and Russia are sticking to their planned oil cuts despite tensions in the Middle East didn’t do much to bring oil bulls back to the market on Monday.
However, Saudi Arabia and Russia reiterated over the weekend that they will maintain their production cuts through the end of the year. Saudi Arabia will continue to pump 1 million barrels less per day and Moscow will export 300,000 barrels less per day.
The IEA still believes that a wider conflict in the Middle East could cause Saudi Arabia to revise its production plans, but economists at Bloomberg now say that Saudi Arabia may need oil prices to rise to $100 a barrel to fund expensive projects, including the futuristic city of Neom, and to finance the purchase of high-profile footballers and golfers. If that means the world has to suffer a deeper energy crisis, high inflation and poverty, so be it!
But even though the Saudis will do everything in their power to keep oil prices above $80 a barrel and rising (and saying they will extend production cuts into next year should be enough to bring the bears to their knees), the dour economic outlook and weak manufacturing data around the world will likely limit gains before we get close to that coveted $100 a barrel level.
