Wall Street recovered as bond yield eased on lower oil

On Tuesday, Wall Street Futures were dragged by more hawkish than expected comments by Fed’s Mester, while also got some support from less hawkish comments by Fed’s Bostic. But Wall Street Futures tumbled soon after hotter than expected JOLTS job opening reports, which may keep the Fed for another +25 bps hike on 1st November and the continuation of higher for longer policy. As a result, the USD/US bond yield also surged, while Gold slipped as the US10Y and 30Y bond yields reached their highest level since 2007, with the longer-term bond trading above 4.9%. The US10Y bond yield made a 16-year high around +4.8%, while the 2Y bond yield, more closely associated with the Fed’s repo rate, also made a multi-year high around +5.15%.

On Tuesday, blue-chip DJ-30 stumbled almost -600 points from the session high and closed around 33175 (-1.50%); tech-heavy NQ-100 tumbled -1.90%, while broader SPX-500 slumped -1.4% to its lowest levels since June’23 on Fed’s higher for longer policy stance and surging USD/US bond yields, both negative for U.S. MNCs.

In the early European session Friday, Dow Future made a fresh panic low around 33020, but soon recovered as USD slips and GBP, EUR surged on better than expected U.K./Eurozone service/composite PMI data along with less dovish talks by ECB and BOE policymakers. Also, less dovish jawboning and a suspected FX intervention by BOJ overnight helped to ease USDJPY and also overall US dollar index (DXY). Subsequently, Dow Future surged to a session high of around 33275 by the start of the U.S. session.

On Wednesday, some focus of the market was on ADP private payroll job data ahead of official NFP job data on Friday. The Fed will now watch September’s labor market and core inflation data before any rate action stance on 1st November. Although the Fed may go for another +25 bps calibrated hike, the market will watch the underlying tone; i.e. whether it’s a dovish or hawkish hike.

ADP Survey data: U.S. Private Companies (establishments) job creation slid in September; the lowest since Jan’21

On Wednesday, the ADP flash data shows Private nonfarm payrolls in the U.S. (only private establishment/business employees) added +89K payroll jobs in September from +180K sequentially (m/m) and +262K yearly (y/y), lower than the market expectations of +153K, and also lower than the +160K NFP/BLS Private Payroll expectations by the market (to be released on Friday).

In September, as per ADP data, the U.S. services sector added +81K private jobs, supported by leisure/hospitality (+92K), financial activities (+17K) and education and health services (+10K), while dragged by professional & business services (-32K), and trade, transportation and utilities (-13K). The U.S. goods-producing sector added only +8K private jobs supported by construction (+16K) and natural resources/mining (+4K), while dragged by manufacturing (-12K).

In September, the U.S. large establishments (big corporates) drove the slowdown, losing -83K jobs and wiping out gains they made in August. On the other hand, small companies (SMEs) added +95K jobs and mid-sized ones (MSMEs) added +72K. Meanwhile, annual wage growth for job stayers slowed to +5.9%, the 12th consecutive monthly decline. Pay gains also shrank for job changers to 9.00% in September from +9.7% sequentially.

The ADP said:

·         September showed the slowest pace of growth since January 2021, when private employers shed jobs

·         Large establishments drove the slowdown, losing 83,000 jobs and wiping out gains they made in August

·         We are seeing a steepening decline in jobs this month.

·         Additionally, we are seeing a steady decline in wages in the past 12 months

 

 

As per the ADP survey, the nominal number of private employees was around 129045K in August. The YTM average of private job additions as per the ADP survey is now around +235K against the NFP/BLS survey of around 191K (assuming September job additions are around 160K). At a glance, looking at the sequential and yearly trend of both ADP and BLS survey data, the NFP Private payroll should come to around 160-150K in September.

Although overall, the ADP Private payroll job report was softer than expected, Gold and Wall Street Futures were briefly boosted before stumbling again as this may not change the Fed’s plan for at least another hike in November or December’23 and a long period thereof at least till H1CY24 (without any cuts). Also, most of the time except in August and May’23, there are significant divergences between ADP and NFP private payroll data.

The S&P Global: U.S. Service PMI lowest since Jan’23

On Wednesday, the S&P Global final data shows Services PMI for the US was revised slightly lower to 50.1 in September from a preliminary of 50.2; and lower from 50.5 sequentially- continuing to point to the weakest performance in the services sector since January, as business activity stagnated amid weak demand conditions.

New orders fell for a second month due to lower domestic and foreign client demand. Also, companies depleted their backlogs of work at the fastest pace since November 2022 to sustain current business activity levels. Nonetheless, firms continued to build workforce numbers amid strong output expectations for the year ahead. Input costs rose at a marked pace that was similar to that seen in August, but efforts to pass on higher costs to customers led to a faster uptick in output charges. Finally, business confidence matched that seen in August but remained below the series trend. Optimism was pinned on investment in new service lines and greater marketing, as well as hopes of stronger customer demand.

Finally, the S&P Global final data shows US Composite PMI stood at 50.2 in September, slightly up from the preliminary estimate of 50.1; and unchanged sequentially- indicating broadly unchanged business activity across the private sector for the second consecutive month. The service sector's output stagnated, while manufacturing production returned to growth, although the expansion was modest. New orders saw a sharp decline, and backlogs of work fell at a faster rate, while employment continued to rise at the quickest pace since June.

On the price front, input costs and output charges increased at faster rates than in August, driven by rising material and transportation costs due to higher oil prices. Finally, firms were more optimistic in their expectations for output over the coming year in September, largely influenced by an uptick in confidence among manufacturing firms.

The S&P Global comments about the U.S. Composite PMI for September:

"The final PMI data for September added to indications that the US economy has started to cool again after a resurgence of growth earlier in the summer. Inflationary pressures in the service sector meanwhile remain uncomfortably sticky. The biggest change in recent months has been the waning demand for consumer services, such as travel, tourism and recreation, along with a slump in financial services activity.

Providers of consumer-oriented services report that a revival of demand in the spring has gradually lost momentum amid the ratcheting up of interest rates and increased cost of living at a time of diminishing savings. In the financial services sector, financial conditions are tightening and uncertainty about the outlook is subduing confidence. Both sectors are now reporting falling activity levels, taking away a major source of support to the wider economy's expansion.

The economy therefore looks to be moving into the fourth quarter on a weak footing, hinting at slower GDP growth as we head toward the end of the year. Average prices charged for goods and services meanwhile continue to rise at a rate well above the pre-pandemic average, with service sector charge inflation remaining especially stubborn, in part due to recent oil price hikes."

Overall, the S&P Global PMI survey shows slowing economic activities, but still, elevated & sticky core inflation led by the service sector and the resurgence of goods inflation amid higher oil/elevated energy/logistic and raw material costs; i.e. stagflation-like scenario.

On Wednesday, the ISM data showed the U.S. Service PMI eased to 53.6 in September from the six-month high of 54.5 sequentially, in line with market expectations. The result pointed to the ninth consecutive expansion for service sector activity to mark 39 periods of growth from the last 40, consolidating the strong momentum for the service sector despite the aggressive tightening campaign from the Fed. Business activity advanced by 1.5 points to 58.8, pointing to a sharp pace of output as another contraction in the backlog of orders (+6.8 to 48.6) offset the ninth consecutive slowdown in new order growth (-5.7 to 51.8). Additionally, prices continued to grow at a sharp rate (unchanged at 58.9), largely due to increasingly high labor costs and a renewed upturn in energy.

Market wrap:

On Wednesday, Wall Street Futures and gold stumbled from post-ADP highs as PMI surveys are indicating elevated & sticky core inflation despite the cooling of the economy. But Wall Street Futures recovered as USD/US bond yield slips on fading concern of high inflation as oil tumbled over -6% as EIA forecasted subdued demand and as Russia may restart export of diesel/gasoline. Also, U.S. is now producing almost 13 mbpd, at a lifetime high, while gasoline and crude stocks are also increasing.

On Wednesday, Wall Street was boosted by consumer discretionary, communication services, techs, materials, real estate, financials, consumer staples, healthcare, and industrials, while dragged by energy (lower oil) and utilities to some extent. Blue Chip DJ-30 recovered from around 33100 to 33350 and closed around +0.39% higher, while tech-heavy NQ-100 jumped +1.35% and broader SPX-500 surged +0.81%, led by blue chip techs (Tesla, Nvidia, Microsoft, Amazon, and Meta) as bond yield eased after oil slid. Dow Jones was boosted by Microsoft, Amgen, Walmart, Nike, Apple, Intel and JPM, while dragged by Chevron, Caterpillar, Verizon, Boeing and Walgreens Boots.

Conclusion:

The Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a final pause in Dec’23.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); H1CY23 average core inflation around +5.40% (~5.50%)

As there is no significant easing of core inflation, especially core service inflation, the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle. But, if core CPI inflation indeed eased further to below +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

Looking ahead, oil prices may stay elevated in the coming months between $75-95 instead of the earlier $65-75 despite US efforts to bring more supply from, Mexico, Brazil, Iran, Iraq, and Venezuela. OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $90 will continue to boost energy/transportation/logistics costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $85 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

Going by the present trend/run rate, the U.S. core CPI may fall to +3.8% by Dec’23 and +3.4% by Feb’24, which may keep the Fed to hold on rates at +5.7% till at least Aug’24 before going for any rate cuts -25 bps or even -50 bps each in Sep’24 and Dec’24. Fed would like to boost Wall Street as well as Main Street before Nov’24 U.S. Presidential election. Fed has to ensure a soft landing; i.e. price stability along with financial/Wall Street stability and Main Street stability.

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing.

Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election. The Fed is itself eager to cut its losses by cutting rates. The U.S. 2Y bond yield is now hovering around +5.13% and may soon scale 5.25-5.50% in hopes of another +25 bps Fed rate hike for a terminal repo rate of +5.75%.

Bottom line:

Technical trading levels: DJ-30, NQ-100 Future and Gold

Whatever may be the narrative, technically Dow Future (33175) now has to sustain above 33300-500 levels for any recovery to 33850/34000-34150/34250 and 34300/34555-34600/34825-35070/200-415/850 levels; otherwise, sustaining below 33000 may again fall to 31700-31500 levels in the coming days.

Similarly, NQ-100 Future (14799) now has to sustain over 14600-550 levels for any recovery to 14925/15150-15325/15500 and 15750/900-16000/655 in the coming days; otherwise, sustaining below 14500 may further fall to 14300/175-100/13890 and 13650-13125 levels.

Gold (XAU/USD: 1823) now has to sustain above 1843 for any recovery to 1867/1875-1885/1900 and 1910/1920-1926/1937 and 1952/1970 levels; otherwise, sustaining below 1837-1832, may further fall to 1825/1813*-1798/1770 level in the coming days.