Vaccines vs. payrolls

The US economy is firing on all cylinders. The labour market report for March was significantly better than expected, which suggests that the US could see spare economic capacity narrowing in the coming months, which might lead some to fear that inflationary pressures could bubble over. When inflationary fears rear their head, it leads to concerns that the Fed will tighten interest rates sooner than expected. This tension between a strengthening labour market and an ostensibly dovish Fed has raged in the financial markets since Joe Biden took office in the White House and the Democrats were confirmed to have control of the US Congress back in January. Another month of strong jobs growth in the US, could see the pendulum swing in favour more inflation and a less dovish Fed, but beware, the Fed is unlikely to give up its dovish mantra too quickly, especially if covid infections continue to rise across the US. Next week we will get the minutes from the March Federal Reserve meeting and we will also be keeping an eye on the level of Covid infections. The most important event may be Fed chair Powell’s speech on Thursday 8th April, where the market will be looking to gauge any shift in the dovish message that Powell has pedalled this year. 

Stellar jobs growth boosts tech stocks 

Looking at the NFP data in more detail, there is no denying that this was a strong report. 916k new jobs were created, which was significantly better than the 647k expected. Jobs growth was broad based and added to this, the unemployment rate fell to 6% from 6.2% in February. Although average hourly earnings on an annual basis missed expectations, they are still a strong 4.2%. This report is raw material for inflation: more people employed, earning higher wages = the risk of stronger inflation. Whether or not this inflation is feeding through to the real economy could be seen in next week’s ISM reports. The ISM services sector index for March is released on Monday. The prices paid component is expected to fall back to 68.3 from 71.8, but the risk is that the economy is running hotter than economists’ have been expecting, so the data could surprise to the upside, akin to the employment report. In trading terms, a stronger ISM survey on Monday, particularly the prices paid component, is further ammunition for the inflation hawks. On the back of Friday’s payroll report we saw a 5-basis point move in the 10-year Treasury yield, the 2-year yield, which is sensitive to near term interest rate expectations, rose to a multi month high, and had its largest daily move (prices fell) for a year. The bond market is definitely positioned for a less dovish Fed, and bond bears will be hoping that Fed chair Powell will confirm this view when he speaks next Thursday. 

What next for US stocks 

Interestingly, the recent link between rising bond yields and stock market volatility was disrupted at the end of this week. A strong labour market report and the 10-year Treasury yield rising back above 1.72% did not weigh on stocks and the S&P 500 has started the second quarter on a high, reaching another record high on Friday at 4,019. Tech stocks, which have been sensitive to rising yields due to the risk posed to their future valuations, surged today. The technology and energy sectors were the best performing sectors on the S&P 500 on Friday, which suggests that the market could be at a turning point. Whereas earlier in the year rising bond yields caused investors to shun tech stocks, if rising bond yields are being vindicated by extremely strong economic data then tech is back in fashion. The big hitters rose strongly on Friday, with Alphabet, Google’s parent company, up more than 3%. Snowflake, the data cloud company, rose 3.5% and Zoom rose 1.5%. This is a sign that the stock market themes that dominated during the peak of the Covid crisis in 2020 may still dominate as we move through 2021. We would note that volumes were thin on Friday due to the Good Friday holiday, this is also the case for Easter Monday, so we will be looking at Tuesday’s price action to see whether positive risk sentiment can continue alongside rising Treasury yields when volumes return to more normal levels.  

The pound’s chances of regaining $1.40 vs. the USD 

In the FX space, interestingly, the dollar index failed to capitalise on the stronger Treasury yields. This further confirms stickiness around the 93.00 level. We will be watching this level closely, if the DXY’s recent rally can extend beyond this level then we could see some significant shifts in the FX space. In the coming week, we are interested in GBP/USD as we could see this pair attempt to retake the $1.40 level. The technical indicators still suggest that this is a buy. A wavering dollar combined with decent PMI readings for the UK for March could trigger some sterling strength. We also think that Covid infection rates could come back into play for the FX space. Parts of Europe have gone back into lockdown, and infection rates are rising across Europe and the US. The strong vaccine rollout in the UK seems to be protecting the UK from this third wave of Covid for now. For as long as this latest Covid wave can avoid infiltrating the UK, we think that this is good news for sterling in the week ahead.