There once was a theory on rates
Explaining, that, here in the States
Recession would cause
Chair Powell to pause
And end all soft-landing debates

But data of late has been stronger
Encouraging ‘higher for longer’
At this point it seems
Recessionist dreams
Could not have been very much wronger

Which leads to today’s NFP
The data point all want to see
If once more it’s high
Look for yields to fly
If low, look for stocks filled with glee

Recently, the US data releases have been anything but benign as they show continued economic strength in the face of many headwinds.  Yesterday’s numbers were overwhelmingly positive with the ADP Employment Change +497K, more than twice expectations and the highest since February 2022.  There is certainly no indication from this data series that companies are cutting back on their hiring.  As well, the ISM Services results were firmer than expected, with the headline jumping to 53.9, up nearly 3 points on the month and more than 2 points higher than forecast.  But more impressively, both the Employment and New Orders readings were much higher than last month indicating a more robust economy than many had been both describing and expecting.

 

But this is all simply a leadup to today’s NFP report, the data point upon which I have been most highly focused as the key for understanding the Fed’s reaction function.  As I have consistently highlighted, if NFP continues to grow and the Unemployment rate remains low, the Fed has ample cover to continue to tighten policy via both higher interest rates and balance sheet reduction (QT) without concern over political blowback.  After all, if jobs remain plentiful and wages continue to grow, complaints of overtightening will have no credibility.

 

Heading into the number, here are the latest consensus forecasts according to Bloomberg:

 

Nonfarm Payrolls	230K
Private Payrolls	200K
Manufacturing Payrolls	5K
Average Hourly Earnings	0.3% (4.2% Y/Y)
Average Weekly Hours	34.3
Participation Rate	62.6%

 

While the headline is, of course, just that, the number that will get the most press, it is worthwhile watching the Weekly Hours data which, as can be seen in the below Bloomberg chart, has been declining steadily since early 2021.  The key, though, is to recognize that the only time we have been below 34.3 is during the past two recessions, so a continuation lower in the recent trend may bode ill for future economic activity.  The thesis here is that companies will reduce the hours of their staff before actually firing them given the expense of bringing on and training new staff in the next up cycle.

 

In the meantime, investors and traders are taking their cues from the data already seen and are increasingly accepting of the higher for longer thesis the Fed has promulgated for the past year.  Yesterday’s price action was dramatic with Treasury yields surging through 4.0% in the 10-year and 5.0% in the 2-year.  This morning that trend continues with yields higher by another 3bps and you can be sure that if the overall employment report is strong, they will go higher still.

 

At the same time, equity markets are starting to feel a little pressure after what has been a remarkable rally in the first half of 2023, as the 4.0% level in 10-year Treasury yields has led to the breakage of things consistently during this cycle.  It started with the UK pension problems and Gilt market collapse in September 2022, was followed by the BOJ being forced to intervene to prevent the yen’s collapse in October 2022, then the FTX collapse in November 2022 and finally Silicon Valley Bank’s demise in March 2023.  In each of these cases, the 10-year yield traded above 4.0% ahead of the problem and was taken back down in the wake of the outcome.  This chart from the Gryning Times makes the case eloquently:

As such, it should be no surprise that equity markets fell yesterday in the US and overnight in Asia as we are clearly reaching a pain point in the market.

 

Of course, the question is, will this time be different?  Have investors priced in higher yields already and still comfortable paying extremely high multiples for stocks?  History has shown that this time is never different when it comes to investor behavior.  Euphoric predictions are followed by reality setting in and eventually prices adjust lower, reverting to long-term means, especially with respect to earnings mulitples.  But that is not to say things will be unable to defy gravity for longer.  As Keynes famously told us all, markets can remain irrational longer than you can remain solvent.

 

Based on all the data we have seen recently, there is no reason to believe that today’s NFP number is going to be weak, nor that the Unemployment Rate is going to rise sharply.  Rather, a higher than consensus number seems quite viable as a baseline expectation.

 

Remember, too, that the Fed continues to hammer home its message of higher for longer with Dallas Fed President Lorie Logan the latest to say so yesterday, “I remain very concerned about whether inflation will return to target in a sustainable and timely way.  I think more restrictive monetary policy will be needed to achieve the Federal Open Market Committee’s goals of stable prices and maximum employment.”  There is nothing ambiguous about that language, that is for sure.

 

Perhaps the most surprising thing about markets this morning is the fact that despite the rise in Treasury yields, the dollar is mixed at best, and arguably slightly lower.  Certainly, versus its G10 counterparts, it is broadly softer with the yen the biggest gainer, 0.5%.  This behavior is somewhat incongruous given the close relationship the dollar has had to US yields.  The dollar-yield relationship is much clearer in the EMG bloc where the greenback is stronger vs. virtually the entire segment.  And I expect that we are going to see a continuation of the dollar gains if US yields continue higher. 

 

But for now, all we can do is sit back and await the data.

 

Good luck and good weekend

Adf