2024.09.09Weekly
There was a sense of deja vu building last week about how the events unfolded on the market and the ensuing action — took me right back to the lead-up into the Black Monday sell-off that marked the bottom and a rebound helped by the classic Turnaround Tuesday.
Might we see a repeat this time round? While I don’t feel the same level of conviction as I did last month which was centred around fading the recession narrative and Sahm-rule trigger hype, if we were to follow the same August playbook, we’d probably be betting that the labour market isn’t cracking to the extent that it may amount to a policy error from not starting with a 50bps cut nor consecutive 50bps cuts into year-end; and by extension, we’d also be betting that earnings and growth expectations holds up going into 2025.
Let’s review the data and assess whether that’s a bet worth making …
Data review
Starting with ISMs, there was slight beat on Services and slight miss on Manufacturing versus expectations.
Looking at the key components for Services — the July rebound in Business activity has held up in August, New orders accelerated, Employment remained in expansion and Prices are still holding an upward bias. For Manufacturing, the slump continues. Overall, ISM is pointing to a positive growth outlook for the Services-oriented economy while some price pressures remain, i.e. not quite supporting the urgency for rapid cuts.
Unemployment claims came in slightly below expectations once again. Given that we tend to see seasonal adjustments higher at this time of year, I tend to consider any below expectation prints to be strong. On a seasonally unadjusted basis, Initial claims pushed lower to its lowest level since October last year, and Continuing claims continues to rollover and back the lowest levels last seen in early June. This suggests to me that the Fed can afford to be patient.
NFP on the other hand continues to be concerning. +142k headline missed expectations of 164k along with yet another downward revision to prior months making it the 4th consecutive one so far. Manufacturing payrolls was negative while Government payrolls continued to take up the bulk of all job gains. Employ America’s (EA) summary shows the latest changes was perhaps not all that bad.
A drop in both Participation and the Unemployment rate could be taken as a slight positive (that the drop in unemployment was not driven by higher participation); Wage growth is on the rebound; JOLTS indicating some softness but nothing to be alarmed of just yet. Despite some positives, EA continues to argue that the broader trend warrants a 50bps cut at the next meeting:
In early July, after the release of the June data, I wrote that the unemployment and inflation data up to that point justified a cut in July. The subsequent two months of data have shown the labor market to be continuing the cooling path that we’ve been highlighting for months, and given that the Fed did not cut in July we think it appropriate for the Fed to do 50 bps in September. That argument does not rely on an assessment that the labor market is currently in recession, but rather a recognition that staying on this path is likely to lead to the labor market falling short of full employment.
While I appreciate EA’s reasoning, I don’t see the Fed going for it. Even though Chairman Powell and co. is shifting their focus towards their maximum employment mandate, they appear to not only accept that the Unemployment rate will be steadily rising, but also completely fine with that to some degree. In other words, I don’t the Fed shares the same level of urgency as many labour market economists.
Also, returning to the point about rebounding wage growth, which oddly didn’t seem to be talked about very much from what I’ve seen, it’s still very strong — 3month annualised pace has accelerated to 3.84%, the fastest since April. To put that into perspective, latest July inflation readings on a 3-month-annualised basis was running at:
- +1.72% core PCE,
+0.90% headline PCE - +1.27% headline CPI,
-0.30% CPI ex-shelter
-0.47% CPI ex-food/shelter/energy/used-cars
Seeing 3–4% wage growth against those numbers would not seem to warrant a faster pace of cuts — I would think…
Lastly, as EA also touched on — Williams and Waller was the last hope for some early hints before the FOMC blackout period had begun, but they didn’t appear to sound the need to jump to a 50bps cut just yet.
August repeat?
If we are to believe that we could follow the August playbook, I think that would require us to take a view that the labour market isn’t cracking enough and nor is the growth outlook. I think thats a reasonable view to take based on the data we are seeing and the sell-off in risk — 1) initial claims falling and consecutively below expectations, 2) ISM services (especially New Orders) is looking quite positive, 3) Wage growth is still very strong…
4) strong companies earnings growth is expected, and with 5) the cutting cycle to start shortly, that should be a strong enough backdrop to keep the overall growth story humming along.
What I am somewhat unsure about is Elections related volatility. As I had expressed in my prior notes, I remain skeptical that elections will have a signficant bearing on markets. Volatility may be more elevated during this time, but I think monetary policy and macro data will be the bigger focus, both of which I think will stay favourable for risk in general.
Looking ahead
Another busy week — in addition to the above, we also have the first Presidential debate, as well as an AAPL event that is intended to showcase the new iphones AI capabilities.
EQUITIES
ACWI all countries index has broken down from its double-top, slicing through through July resistance levels (shaded Red box), and looks to be eyeing a retest of the 50fib region which has been a major pivot of which the August rally has ripped right through and has left untested.
SPX closed into support just above the 5400 handle, and a heavy close suggests an overshoot below to the next pivot area in the mid-5300s where there are strong technical reasons SPX could find a swing low: 1) would fill the last remaining gap of the August rally, 2) major pivot region that has seen a series of support/resistance that coincides with 50–61.8 fib, and 4) untested pivot region after the ripping rally.
Looking at volatility metrics, last week showed an interesting divergence between index volatility measures continuing higher (top panel: VIX, VIX front 2-month spread, 1-month implied correlation), and downside protection premiums easing off from the Tuesday peak (middle: Skewdex and Taildex). And while the SPX put/call ratio continued to go increasingly bearish, it’s close to approaching the 90th percentile bearish extreme — above which one could take a contrarian view.
Open interest on SPX options is looking very short-gamma (more in-the-money puts than calls). Given the extremely bearish close last week, the risk is high that the sell-off can accelerate under short-gamma conditions as downside forces more delta-hedge selling by market makers. But should the sell-off come to a stall at some point or begin to put in a strong recovery, that would be fuel for a squeeze and recovery.
Looking at the options chain — specifically near-term Max Pain levels, we can roughly estimate that neutral-gamma levels is roughly about 2–3% higher in the mid-5500s. I’d therefore say that if SPX starts to make a recovery above 5450 and 5500, I’d think the squeeze may well be under way.
COMMODITIES
Bloomberg commodities index had its worst week since mid-July with price action pointing to more downside. It wasn’t until the NFP report that the sell-off became broad-based however.
Energy -4.58% led the downside followed by Industrial Metals -4.55%, while both Precious Metals -0.88% and Agriculturals -0.36% finished in the red after attempting a rally earlier in the week.
We had something similar in the price action around the July NFP, but what continues to puzzle me is the reaction in Gold where I would have expected it to rally on the NFP misses. I still like trading around the downside in Gold however based on how dovish the market is — more on this next.
RATES & FX
Yield curve down shifted by a fair margin with more bull steepening over the last week with the 2yr -27.7bps and 10yr -20.1bps, resulting in the 2s10s to un-invert with the 2yr at 3.65% and 10yr at 3.71%.
Market is now pricing in decent odds for 100–125bps of cuts by year end which is looking like an awful lot based on the totality of the macro data we are seeing. Perhaps some ~100k-120k NFP prints (being below the lower end of the breakeven rate of job growth, as highlighted by EA), could begin to justify that pricing, but until then, I think the market is at risk of being wrong-footed than not.
For FX, strong correlation to policy rate expectations remains (white line heading downwards is pricing in more cuts, upwards is pricing in less). Assuming that it is 1) unlikely the market can price in deeper cuts by year-end, i.e. maxed out pricing skews risks towards unwinding, and 2) USD deeply oversold and relative to those moves, I favour tactical USD buying at these levels vs JPY CHF EUR, and possibly the GBP if there is a risk-off flavour to around the period of trading.
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To conclude, I do think the August playbook could very well playout. With growth slowdown concerns being the main macro narrative, I think it will prove resilient enough such that rates could be stickier than market pricings suggest. I favour late-cycle thematics — NDX over small-caps, as well as the USD to retain resilience on a relative-value basis.
I’m always interested to hear what people think about my views, so please feel free to leave a comment or shoot me a dm. With that, I bid you good trading!
