It’s only Monday but it feels like markets already have plenty to digest this week.
Geopolitical tensions remain up in the air. Higher oil prices. Surging bond yields. Stocks and gold under threat again. It’s all to play for with month-end and quarter-end volatility also set to kick into gear.
But in terms of macro catalysts, the big one is arguably the US jobs report that will only come on Friday.
The main worry for markets right now isn’t that employment conditions suddenly look weak. It’s almost the opposite.
US economic activity has remained surprisingly resilient despite higher rates, and that resilience is becoming more and more difficult for the bond market to ignore. The September flash composite PMI jumped to 58.4, its strongest reading in more than five years, with the details also revealing that both employment growth and price pressures are running hot.
I would argue that changes a bit on how traders need to think about the upcoming jobs numbers.
Typically, strong employment is good news. More jobs would mean households have better income, helping consumption to stay supported and companies get a healthier economic backdrop.
However, this isn’t one of those typical cases in point.
The Fed just raised interest rates by 25 bps to 3.75% to 4.00%, its first rate hike in more than three years, with policymakers also signaling that further tightening may be needed to bring inflation under control. And then you have 10-year Treasury yields already having pushed through the psychologically important 5% level this month.
So, another resilient jobs report could quickly turn into the familiar “good news is bad news” trade for markets. And with yields now already fast approaching 5.20%, the stakes are considerably high.
In looking to the jobs report, the key isn’t simply payrolls growth either. I’d be paying just as much attention to unemployment and, perhaps more importantly, wages. Strong hiring accompanied by accelerating wage growth would reinforce the argument that domestic inflation pressures remain too persistent for the Fed to rest on their laurels.
In turn, that could keep upward pressure on Treasury yields, weigh on rate-sensitive technology stocks and give the dollar another tailwind.
But on the flip side, a softer report creates a more interesting question for markets.
Do Treasury yields gather relief in retreating lower? Do tech stocks rally as discount rates fall? Or do broader markets start worrying that higher borrowing costs are finally beginning to reach the real economy instead?
That final question is something that will be crucial in defining how upcoming US economic data could help define the next market regime.
The past few weeks have largely been dominated by supply-side inflation risks from the oil market. But now, labour market data brings the focus back towards domestic demand.
And if energy inflation is running hot at the same time as employment and wages with the demand backdrop remaining strong, the Fed has a considerably bigger problem to deal with.
In turn, the question that the bond market may have to start asking next is whether 5% yields is actually restrictive enough.
This article was written by Justin Low at investinglive.com.