US equities were weaker Thursday, with S&P 500 down 1.1% heading into the close, reversing earlier gains. US10yr yields down 7bps to 3.92%, 2yrs down 15bps to 4.92%.
A miss on US jobless claims, with initial up 21k to 211k, continuing up 69k, both weaker than expected and reversing a recent downtrend triggering a steep drop in 2-year yields as a flight to safety ensued after extreme weakness in the most interest rate-sensitive sectors like housing saw mortgage lenders and banks diving in the plunge tank overnight.
In days like this, “bad news is indeed bad news,” especially when the potential of massive mortgage defaults enters the market purview. Even the swelling jobless ranks offered little relief to nervous investors. Traders draw a straight line from bulging jobless ranks to mortgage defaults and rotate into safety.
The Fed is probably getting asked to do too much to solve the structural labor side issue. But provided they are prepared to use their most blunt tool, higher for longer interest rates, it will be challenging to express a lasting” risk on view” given that the choppy policy waters may not offer as plain sailing as it was at the beginning of the year.
With US stocks notably lower and yields on 10-year Treasuries also falling now, investors may be growing concerned that until prices plunge even at the cost of a shallow recession, the Fed needs to tame the post-pandemic inflation impulse we have been experiencing for over 18 months. Hence some smart money is rotating out of stocks into US Govies and Gold.
Mortgage rates sustained at two-decade highs are taking their toll on housing market activity and prices. The US downturn is more substantial as the decline in existing home sales has increased and is more profound than in 2007-10. However, prices have only erased year-over-year gains, and existing home inventory remains very modest on a historical comparison. Nevertheless, the continued record low in Univ. of Michigan homebuyer sentiment and housing affordability measures suggest further weakness is ahead.
Today’s market action is coming ahead of Friday’s critical Payrolls report, which could shed further light on how strong the US economy is.
The strength of the US economy has been in focus for quite some time now but took on an additional layer of scrutiny following comments from Fed Chair Powell earlier this week.
If the Fed does start to hike more aggressively again, investor concerns around a US economic soft landing may rise again — a factor that could also be weighing a bit on stocks today. Interestingly, only last week, investor concerns were more around an economic reacceleration; now they are back to worrying about potential policy mistakes. Given that the lags inherent in monetary policy create risks of policy error in both directions; hence one needs to factor in the possibility of a hard landing.
So perhaps this will be the nature of trading for the next bit: oscillating between too-hot growth and too-hawkish policy, then returning to medium-term growth fears but then back to growth is good enough to prevent a hard landing. Get the picture ?? The post-pandemic era has not proven to be an easy one to trade.
Macro investors were the big oil seller overnight as the Oil complex fell under the macro malaize of mortgage concerns, policy mistakes, and hard landing probabilities as oil traders are caught in the hawkish Fed loop. At the same time, optimism around China keeps the oil price somehow above $80/bbl.
However, after yet another setback, traders will become even more wary, demanding fresh macro evidence to invest in the structural bull thesis. So until China’s economic data lights up or the Fed turns less hawkish, it could spell trouble for oil prices over the short term.
Gold is higher on a flight to safety and amid the omnipresent rumors that China is in the markets buying for US dollar diversification purposes.
Gold’s downshift to the low 1800s provides the buying opportunity many hoped for, but renewed upside inflation concerns and a more hawkish Fed, may not yet have run their course. Hence the next dollar direction will drive gold sentiment.
BANK OF JAPAN PREVIEW
BoJ will meet for the last time under Governor Kuroda amid increasing speculation of a ‘legacy’ change to policy. However, most Tokyo economists do not expect any change because the BoJ may be concerned about making adjustments into fiscal year-end and because the results of the shunto Spring wage negotiations have not been announced yet.
If no imminent policy change proves, correct, USD/JPY can move more freely with US real rates. For now, risks appeared skewed toward higher US rates; however, that could change quickly if US rates start to see some relief, perhaps due to renewed recessions concerns on payback in the upcoming activity data, especially if that also leads to a more dovish March FOMC meeting after expectations have repriced significantly higher over the last couple of days.
Earlier this week, Fed Chair Powell indicated that in light of recent robust data, most Fed officials now expect a somewhat higher terminal rate than they previously estimated in the December Summary of Economic Projections. In addition, Powell sent a clear signal to the market that should the incoming data warrant it, the Fed would raise rates at a more aggressive pace over the coming meetings.
Due to extreme weakness in interest rate-sensitive parts of the market that directly negatively impact “Main Street,” we think there is a strong chance for a 25bp rate hike at the March meeting and a 5.6% terminal rate reached in July. However, Powell lowered the bar for a 50bp hike in March, so the strength of the February employment report will be crucial to the Fed’s upcoming decision.