Attack the Week (ATW)
I am still travelling, so I will keep it nice and short this week. I have already opined on Friday’s chart book (see below) on the state of play after the somewhat lukewarm but not disastrous payroll numbers. As we enter a potentially pivotal week with CPI, I will refer you to Macro D’s current thoughts, the outlook on the weekly calendar, and the top 10 charts I am considering as I prepare for the new trading sessions.
These are not easy markets, and it’s tempting to extrapolate and panic as volatility increases. This is natural. It is also quite telling how many bears are finally appearing out of hibernation to call the doom and gloom. I am never a 100% or 0% investor, meaning I see probabilities as being more balanced, which is important if you want to survive in the long run. Currently, and supported by our charts below, we have already sowed the seeds for a reversal in risk assets to occur. Timing and extend will of course be the dominant factor to play those odds well. I will elaborate further below.
Macro D Thoughts
In the latest Friday chart book, my dear friend Paper Alfa provided a clear and comprehensive analysis of the current situation, following what has happened in the markets in recent days. I don't have any sparkling revelations to offer you, and I have nothing extraordinary to add to the scenario he has perfectly described, but in my small way, I want to tell you how I spent these last hours thinking about what’s likely going to transpire further ahead. The night between Thursday and Friday was hectic. I was unable to sleep; I struggled to distinguish between Star Trek and Star Wars. What I discovered was that Star Trek focuses primarily on scientific exploration and diplomacy, while Star Wars revolves around a great battle between good and evil. No event in life does not push me to ask myself:
"What just happened, and how can it help me understand financial markets?"
Well, I asked myself this question this time, too. At this point, I had no choice but to wait. Sooner or later, I would find the social field on which to apply the answer I had just given myself.
Let's get to us: we are traders, so what could have been the week's highlight on the financial markets? Let's put our cards on the table.
Introduction: what did I think before the release of the non-farm payroll data?:
- An increase in the unemployment rate would have brought me closer to the word recession shortly and would probably force the indices to a sharp decline.
- A stability of the data or a decrease in the unemployment rate would have removed the word recession from my vocabulary (in the short term).
Sword of Damocles: If Wall Street and the Fed's expectations of a more pronounced labour market weakening are unfounded, the Fed could implement a 50-basis-point cut.
On Friday morning, the nocturnal mystery that had revealed itself the night before was revealed without any particular preciosity. It was enough to think about the jungle of data whizzing past my eyes until then to understand that I was inside (with both shoes) a Star Wars environment rather than a Star Trek one. Now that the knives are sharp, diplomacy is no longer warranted.
There was no time to waste; the critical moment was about to arrive. I had to find the end of the skein.
What's happening? For the first time since June 2022 (not yesterday), the US Treasury yield curve returned to positive territory, with ten-year government bond rates exceeding, albeit by a whisker, their two-year equivalents. This happened after the publication of the JOLTS report on the US labour market and after the statements on rates released by the president of the Atlanta Fed, Raphael Bostic, who said he was in favour of cutting the rates on fed funds even in the event of a US inflation rate still higher than the Federal Reserve's target of 2%.
Rationality requires us to contextualize the word normality in a generally reliable and safe environment, but since rationality is not at all a friend of the financial markets, I force myself, as usual, to perk up my antennae as much as I can. This means bringing in history, which in this specific moment tells me that the yield curve normalizes exactly when the economy ends up going into a real recession or is, in any case, in a recession.
Now, what do we do?
On Thursday, the U.S. Department of Labor announced that its long-awaited Job Openings and Labor Turnover Survey (JOLTS) report showed job openings fell below 7.7 million in July, the lowest since January 2021, confirming a weakening U.S. labour market.
I was thinking pretty clearly at the time.
“A 50 basis point rate cut — that would spook financial markets and could be interpreted as a confession that Mrs Recession is already sitting in the living room. The most likely outcome of the Fed’s next meeting is a 25 basis point rate cut, although recent economic data seems to have strengthened the case for a more decisive move.
When macro data punch each other in the face, what comes out is always a picture that follows the law dictated by the short term. For a brief period, the one who hits harder wins continuously, and those who hit harder than the others take turns. Lately, macro data is hitting hard on our screens, and no one continues on the line traced by the previous one; each one wants to dictate the law. This situation does nothing but exacerbate the age-old question that revolves around the possibility of a soft/hard landing that comes back into fashion (precisely) every time the release of macro data contrasts with the release of the macro data that preceded it.
Given that even the Richmond Fed says we are in recession territory (as the slowdown in employment suggests), now the focus of the markets has shifted from inflation to recession. And then, the highlight arrived: here are the data on US labour, lower than estimates: jobs created (excluding agriculture) were 142,000 more than in July, but analysts expected 161,000. In line with expectations, unemployment fell from 4.3% to 4.2%. The unemployment rate went from 4.3% to 4.2%; in line with the consensus, average hourly earnings grew by 0.4% over the month (estimated +0.3%), double compared to July, and accelerated from 3.6% to 3.8% annually.
The cooling of the labour market in August instantly made me think that the Fed could start the cycle of rate cuts with a heavy hand.
In short, it can be said that the US labor market has performed worse than expected, catching many by surprise. At this point, the table was set.
In concrete terms, with inflation sharply declining and a less dynamic labour market, the Federal Reserve's potential rate cut at its September 17-18 meeting is of considerable importance.
I'll be frank: as soon as the data came out, I thought (complicit in the current psychological situation of market participants, who at the moment are behaving like that father who insists on calling the hospital chief when his little son scrapes his knee slipping on the lawn of his home garden) that the market would interpret the latest data as an excuse to believe in a cut of 50 basis points, rather than 25. I didn't want to give in, so I kept my seatbelts fastened.
While it may feel like we're in a Star Wars script, even in the midst of market 'battles ', it's crucial to maintain a measured approach. I believe it's prudent to await the release of the coming week's inflation data before delving into speculative future scenarios. This data will provide a clearer picture of the market's future. What's undeniable is that following the report's release, Wall Street stock index futures saw an upturn, and two-year Treasury yields dropped to 3.68%, driven by the potential for a half-percentage point cut by the Fed.
But why does the market seem to persist in wanting to believe in a 50 basis point cut? The recent data on job offers show the lowest figure since 2021, and the estimate elaborated by ADP is the lowest of the last three years. This paints a picture of the risk of recession getting close to us. I will never forget that in Jackson Hole last week, Jay emphasised the labour market, which reiterates all its fragility with Friday's data.
I, in my small way, reiterate that at this moment, I do not see at all the urgency of a cut of 50 basis points; if this were to happen, as I have already written in the last Friday Chart Book, it would be a bit like cutting a steak with a katana. It does not seem to be the case, so I trust in Jay's elegant moderation. I believe that Powell and his friends will lean towards a gradual and reliable guideline; like all guidelines, he will not set off like a rocket. A significant cut by the Fed would be the wrong move because it would put an entire planet on alert.