Market Brief: Caution Grows as Payrolls Loom
Traders are signing pre-nuptial agreements with their positions this morning, avoiding exposure to downside risk ahead of a potentially-pivotal non-farm payrolls report. The dollar’s gains are slowing after the biggest weekly advance in six months, Treasury yields are steady, and North American equity futures are flat.
Uncertainty is high. Consensus estimates suggest that the US added 150,000 jobs last month - a pace that would keep the unemployment rate steady at 4.2 percent - but forecasts are widely dispersed, from 70,000 on the low end to 225,000 on the high end. A surprise could radically reshape expectations for November’s Federal Reserve meeting, lifting or depressing odds on a half-percentage-point rate cut, which are currently holding near the 32-percent mark.
A significant risk to the near-term economic outlook was removed last night when the US dockworker strike ended after just three days. The International Longshoremen’s Association and the US Maritime Association agreed to extend their existing contract through to January 15 after employers reportedly offered a 62-percent increase in wages and some protection against increasing automation. The job action had threatened to wreak havoc on supply chains - potentially triggering a rise in inflation - and disrupt measurements of US labour market conditions ahead of the Fed’s November meeting.
Bearish views on the US economy are struggling in the face of still-supportive data. The Institute for Supply Management’s services activity index yesterday climbed to 54.9 in September, well above estimates set closer to the 51 mark, and firmly within expansionary territory as the current activity and new orders measures acted to offset a small decline in the employment component. The services sector accounts for 78 percent of US consumer spending, 79 percent of output, 83 percent of firms, and 85 percent of jobs, making it far more meaningful than the manufacturing sector for observers trying to assess underlying conditions in the broader economy.
The British pound is reversing some of yesterday’s losses after Bank of England Chief Economist Huw Pill outlined his reasons for voting against rate cuts at the last two meetings, saying “there is ample reason for caution in assessing the dissipation of inflation persistence”. “While further cuts in the Bank Rate remain in prospect should the economic and inflation outlook evolve broadly as expected, it will be important to guard against the risk of cutting rates either too far or too fast,” he said, “For me, the need for such caution points to a gradual withdrawal of monetary policy restriction”. Yesterday’s selloff was triggered when Governor Bailey told the Guardian that the Bank could be “a bit more aggressive in cutting rates”.
Oil prices remain elevated as traders brace for a weekend escalation in the conflict between Iran and Israel. Speculation has built around the possibility of an Israeli attack on the Kharg Island export terminal that processes roughly 85 percent of Iran’s oil shipments to global markets, and both Brent and West Texas Intermediate benchmarks jumped yesterday when President Biden replied to a reporter asking “Would you support Israel striking Iran’s oil facilities, sir?” - with a rather ambiguous answer: “We’re in discussion of that. I think - I think that would be a little - anyway”.
A relief rally could lift risk-sensitive assets once Israel carries out its retaliation. More price volatility is likely, but oil markets remain fundamentally well-insulated against a supply disruption: Iran is believed to be exporting around 1.71 million barrels of crude per day, and total OPEC spare production capacity - the volume of production that member states can bring on within 30 days and sustain for at least 90 days - is currently estimated at around 6.88 million barrels per day. Saudi Arabia alone is able to raise output by 3 million barrels per day, the United Arab Emirates can add another 1.4 million, and production growth from non-OPEC countries is still outpacing consumption, limiting the impact that a disruption in exports might have on global supply and demand dynamics. We think safe-haven and high-beta currencies could switch market leadership roles once the next phase of action has concluded, partially unwinding this week’s moves.
More broadly - provided that today’s payrolls report doesn’t upset the calculus - the rebalancing process that has underpinned currency markets this week could have further to run. After getting a little over-optimistic on how quickly the Fed might ease policy, investors seem intent on pushing ten-year Treasury yields back toward the 4-percent handle, adding to the dollar’s upward momentum. Expectations for rate cuts from the European Central Bank, Bank of England, and Bank of Canada are building as domestic data soften, and increasingly-dovish rhetoric from Japanese policymakers is helping cap the yen’s upside. The impact of China’s recent stimulus efforts is likely to fade after a short honeymoon period when onshore markets reopen next week, keeping the renminbi’s gains limited.
Expectations for the US election seem to be stabilising with no clear lead for either candidate, but unease about the consequences for trade relationships continues to rise. The ‘Trade Policy Uncertainty Index’ compiled by Caldara, Iacoviello, Molligo, Prestipino, and Raffo - which counts the monthly frequency of articles discussing trade policy uncertainty as a share of the total number of news articles in major US media outlets - has risen sharply in the last three months as influential Republicans have joined Donald Trump in calling for a dramatic increase in tariffs, and seems set to increase further over the coming weeks as the campaign nears its conclusion. We think this will contribute to a consistent bid for the US dollar, with currencies in major exporting countries struggling to make headway as background fear levels ratchet higher.
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