After spending much of the week firmly locked in rally mode in the wake of Chair Powell’s latest introspections, markets received a bit of a cheeky surprise from an upstart U.S. payrolls report on Friday. Ignoring the pivot script of fading growth and ebbing inflation, jobs instead posted a backslapping 263,000 advance in November, coupled with a sturdy 5.1% y/y average hourly earnings gain.
Both touched down plump on the solid side of expectations and promptly undercut a fast and furious Treasury rally. Still, after the dust settled, U.S. yields ended the week moderately lower, while the S&P 500 eked out a modest gain even with a late-week retreat.
In all fairness to the pivot camp, the solid payroll gain ran contrary to the economic grain of softening U.S. financial data, which mainly points to any icy growth backdrop.
All the pivot talk is driven by the yield curve’s uncanny predictive power of signalling a recession.
The 10-year Treasury note is 77 bps below the 2-year issue, and the negative gap is the widest since 1981. Leveraging the yield curve’s eerie track record as a nasty prophet of doom, the Fed’s recession equation—based on the spread between the implied forward 3-month Treasury bill rate 18 months ahead and the current 3-month bill rate—puts the odds of a downturn in the year ahead at about 60% This means the market sees a reasonable chance of the Fed reversing gears next year mainly in response to a downturn.
Although rate easing is almost always viewed as a positive for equities, the Federal Reserve habitually reacts to economic variables rather than proactively anticipating them. Put another way, they are usually late to the party when adjusting interest rates higher or lower.
To be clear, there is no such thing as a foolproof playbook when it comes to trading rates vs recession probabilities. Still, if the Fed is moving into rate-cut territory, as improbable as that is with inflation at generational highs, there is a good chance they are indeed late to the party.
While stocks struggle to break fresh higher ground, the U.S. dollar has few problems digging lower ground primarily due to the market’s newfound and, some would say, radical perception that the Fed is nearing the end of its tightening cycle runway.
Outside of the usual post-NFP algorithmically driven knee-jerk move, not even a hearty payroll number offered a lengthy lifeline to the buck as the EURUSD is still sitting with ample headroom above 1.05 and GBPUSD at 1.2250
Of course, when FX traders get caught up in pivot mania, not to mention the transactional year-end seasonality factor, they tend to ignore big-picture economic stuff.
The euro and cable desks apparently didn’t get the trading floor memo about the negative implications of rebounding gas prices and the pervasively weak economic fundamentals on the continent and dotting Blighty’s landscape. Indeed there is plenty of near-term ammunition for the doves on the ECB and the BoE. So selling England by the Pound is getting very tempting the closer we get to 1.2300
Published by Stephen Innes, Managing Partner, SPI ASSET MANAGEMENT
