Waiting for payrolls

Another day and another round of watching economic data, however, Thursday feels like the calm before the storm as we wait for Friday’s US Non-Farm Payrolls report for September. Stocks are weaker before the open on Thursday, this comes after Wednesday’s volatility on the back of the much weaker than expected ADP report, which sent bond yields lower and pushed up stock prices. Bond yields are flat after the large increase of the past week. In the last 5 days, the 10-year US Treasury yield, a global benchmark that is vital for multiple parts of the global financial system and used for collateral on multiple trades, has risen by 16 basis points. While yields are stable across the globe on Thursday, the risk of a bond market rout is not far away, and investors remain on edge. This increases the stakes for Friday’s payrolls report, and we expect excess volatility on the back of this single data point.

Central banks are to blame for the global bond yield surge

There are multiple reasons for the recent rout in global bond markets. Is it because the Fed is in a ‘higher for longer’ mode, and expectations for interest rate cuts in the coming months have been slashed? Is it because of a stronger outlook for the US economy, which is indeed outperforming its peers in Europe and in China? Or is it down to an increase in the US debt term premium, the premium applied to hold long-dated sovereign debt? A mixture of all three seems likely, however, a more compelling reason could be a shift in central bank decision making. Investors can’t see a vision for monetary policy right now, and there is no identifiable long-term framework for policy. Today, central bankers are merely reacting to data points. Thus, rogue numbers that are then revised or changed, can cause havoc with markets. Investors are reacting to economic data points, due to what they perceive as weak leadership from the major central banks who are unwilling to provide a policy framework lest they make the same mistake they did when they thought that inflation would prove transitory.

Thus, hamstrung communications from central banks mixed with some strong US economic data, an increase in the term premium, a US credit rating downgrade and a debt ceiling bill that only guarantees funding for the US Federal government until next month are the main culprits for this bout of painful volatility that we are facing.

Why Payrolls will determine where risk sentiment goes next

In the short term, we see a few trades emerging depending on the outcome of economic data. US inflation and labour market data will likely roil markets. Strong inflation could see risk assets sell off and bond yields shoot higher and vice versa if inflation is weaker than expected, while a weak NFP report would also be good news for risk sentiment and could push bond yields and the dollar lower. A strong payrolls report on Friday could spark a blood bath for risky assets. The market is looking for a headline NFP number of 170k, down from 187k in August. The unemployment rate is expected to nudge lower to 3.7% from 3.8% in August, and average hourly earnings are expected to rise by 0.3% last month, with the annual rate of hourly earnings remaining at 4.3%. if the report comes in line with expectations, then we think that the market will view this is a sign of a strong US economy, which could weigh on risky assets. However, a strong US economy is good news for the oil price, and it could be good news for beleaguered emerging markets, as it may increase EM imports to the US.

The FX view: is the strong dollar here to stay?

In the longer term, economic data will determine if the US’s economic exceptionalism will continue. As we mention, a couple of months’ worth of stronger US labour market or inflation data could see the Fed hike rates again in December. Right now, there is only 33% chance that rates in the US could rise to 5.5 – 5.75% at the December 13th meeting, which means there is plenty of opportunity for the market to re-price expectations higher if the US economic data surprises to the upside in the coming weeks and months. Overall, the dollar index is trading in a bullish channel, even if the decline in US Treasury yields on Wednesday caused a mild selloff. The dollar index is still engaged in a 12-week winning streak, asserting its negative correlation with US stock prices. The dollar index is currently trading at 106.20 and 105.90, previous resistance, could act as decent support if we see a further dip in the dollar index from here. The path of least resistance seems higher for the dollar index, so we would not yet try to challenge its dominance. However, it is worth remembering that the authorities might start to get involved to strengthen their currencies, especially if we see another rise in the oil price and more inflationary threats. USD/JPY briefly touched 150.00 earlier this week, which led to a sharp decline in this pair on rumours of official intervention from the BOJ to strengthen the yen. Thus, for the time being, we don’t want to fight the Fed or any other intervening central bankers. If the 150.00 level is surpassed again, we will likely need to see a strong US labour market report on Friday.