Get out the popcorn, it could be an entertaining 48 hours as traders jockey for position in and out of the granddaddy of all economic releases, US Non-Farm Payrolls.
U.S. equities closed well off the day’s highs, even as Treasury yields continued to fall. While surprising to some, it’s intuitive to others who are sounding the “be careful what you wish for” alarm on the back of softer Tier 2 employment data ahead of Friday’s Non-Farm Payrolls (NFP) reading. Without stating the obvious, the US labor market is showing signs of contracting much faster than expected. This is not necessarily a “risk-on” panacea, especially if the downward momentum in the labor markets picks up steam.
While ADP‘s historical accuracy as a predictor of NFP has been weak post-pandemic*, most traders (carbo-based) (as opposed to news reading algorithms) do not place much weight on the ADP miss. However, on the surface, Wednesday’s data can be seen as another piece of the labor market rebalancing puzzle and underscores the dovish message conveyed by Tuesday’s JOLTS release.
However, investors are likely to wait for the more comprehensive labor market data from Friday’s NFP report before making any tactical year-end moves.
While the government’s jobs report is expected to be a game-changer, the bar has now been set relatively high for the report to send an unambiguously strong or hawkish message. Indeed, the softer reading on job openings (JOLTS) may make it harder for the NFP to confirm a coherent picture of a hotter-than-expected labor market. Still, a big number can move the policy needle if for no other reason than the 125 bp+ of rate cuts that were quickly priced in along the curve in the wake of Fed Waller’s recent dovish comments, which more or less greenlighted the wave of rate cut bets.
After last month’s tectonic shift in bond market sentiment and the subsequent meteoric rally in equities, the follow-through dynamics so far this month are showing obvious signs of exhaustion, for lack of a better colloquialism.
While the growth outlook has moderated in recent weeks from the 5%+ pace we saw in 3Q23, the economy does not appear to be headed for a recession in 2024, which – despite progress on inflation – may not force the Fed to cut as aggressively as current market pricing suggests. Combine this with concerns that investor optimism is reaching a potentially precarious level thanks to the +125bp of rate cuts priced into the curve, and you have a recipe for a sell-off in the making on any hawkish Fed push or stronger message in the economic data bottle.
Aside from concerns about overbought technical indicators (if you look hard enough, you can always find a technical level to justify a bad trade), the growing belief that the Federal Reserve may not cut interest rates as quickly as the markets currently expect is probably the biggest concern for stock market investors right now.
Oil MarketsThe fall in oil prices to a 5-month low has been attributed to a supply overhang and concerns about slowing demand.
The latest sell-off intensified during the afternoon New York session following the release of inventory data from the U.S. Energy Information Administration (EIA).The data showed a significant increase of 8 million barrels in total refined product inventories last week.
However, the critical factor in this week’s sell-off is attributed to Saudi Arabia’s announcement of a reduction in the official selling price of its flagship Arab Light crude for January. This decision to cut prices in key markets reflects weak global demand fundamentals.Saudi Aramco implemented a $0.50 per barrel price cut for Arab Light crude for January shipments to Asia, bringing the price to $3.50 per barrel above the Platts Dubai/Oman average.
Similar cuts have been made for other regions, including Northwest Europe and the US Gulf Coast, highlighting the broader impact of reduced demand on oil prices.What is driving this “everything rally”?
Much of last week’s discussion focused on the flow drivers behind November’s historic market moves.In particular, commodity trading advisors (CTAs) and vol control strategies were highlighted as playing a prominent role in market dynamics.
In the managed futures space, there was a reflection of the broader macro policy reversal, with existing positions in hawkish rate bets and bond shorts experiencing a significant one-way buy-to-cover trend. In addition, a notable decline in realized equity volatility triggered mechanical buying of equities from the vol control universe.The combination of these factors contributed to the extraordinary market moves seen in November.According to Goldman’s Scott Rubner (whom Bloomberg amusingly dubbed a “tactical specialist” this week), these dynamics may be largely exhausted.
“The flow-of-funds dynamics that drove the everything rally in November have now absolutely run out of gas,” Rubner wrote, describing the $225 billion in CTA buying last month as “the fastest increase in exposure we have ever seen.
