Daily Comment (April 6, 2023)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EDT] | PDF
Happy Maundy Thursday! Today’s Comment starts with our thoughts about tomorrow’s job report. Next, we discuss possible substitutes to the equity and futures markets to gauge investor reaction to the labor market data. Lastly, we review the latest development in the conflict between the U.S. and China.
Good Friday? Markets will be closed tomorrow when the March employment numbers are released by the Bureau of Labor Statistics, but investors will still be on high alert.
- Signs of a cooling labor market could pave the way for a Fed pause or pivot. On Wednesday, private payroll data from ADP showed U.S. firms added 145,000 jobs last month, well below the consensus forecast of 210,000. The slowdown in hiring was also reflected in the manufacturing survey reported by the Institute for Supply Management and BLS data that showed a sharp drop in job openings in February. The Federal Reserve has consistently pointed to the tight labor market as evidence that it still has room to raise interest rates. Thus, a weak BLS jobs report could pressure the central bank to conclude its hiking cycle before the end of the year.
- Despite Wednesday’s data supporting a more dovish monetary policy, investors are worried about the state of the economy. The service activity index tracked by the ISM showed a sharper-than-expected drop. The index came in at 51.2, well below expectations of 54.5, and the previous month’s reading of 55.1. The subpar economic number weighed on equities as investors looked to lock in temporary gains made earlier in the week. Led by tech stocks, the S&P 500 fell 0.25% on Wednesday, while the NASDAQ sank 1.1% in the same period.
- A disappointing jobs number may convince the Fed to rethink its interest rate strategy. Over the last few weeks, Fed officials have appeared less committed to raising rates. Regional Fed President Neel Kashkari and Thomas Barkin have both been reluctant to advocate for another rate hike in the May meeting. Meanwhile, Cleveland Fed President Loretta Mester has emphasized that the central bank must be “judicious” as it conducts policy going forward. The shift in tone may be related to uncertainty regarding the economy following the downfall of Silicon Valley Bank (SIVB, $106.04) and Signature Bank (SBNY, $0.16) in March. As of this writing, the market has priced in a 67% chance that the Fed will stop hiking rates by June.
Still Open Most Hours: Equity markets may not be open on Friday; however, currencies and bonds will still be trading.
- With it trading until 5 PM EDT on Friday, the forex market will likely be a great place to see reactions to the jobs number. The U.S. Dollar Index shows that the greenback is down 1.5% against global currencies for the year. Its steady decline has been driven by concerns that a looming recession will force the Fed to halt and possibly reverse its policy stance. If the jobs number is softer than expected, global currencies will likely rally against the greenback. However, strong employment data could see the opposite or no reaction at all. Although the DXY Index is based on futures contracts and thus won’t be traded on Friday, movements in the EUR, GBP, and JPY will likely reflect a broader decline in the U.S. dollar relative to its peer currencies.
- Although hours will be limited, fixed income will be another market to gauge investors’ perceptions of the U.S. labor market. The yields on two-year Treasuries have fallen 132 bps since March 7 of this year, while 10-year Treasuries have decreased by 77 bps in the same period. Similar to the DXY Index, the normalization of the yield curve shows that the market believes the central bank is just about finished with its hiking cycle. Additionally, fixed-income securities have been noticeably more sensitive to changes in Fed interest rate expectations. As a result, a strong jobs report may be bearish for bonds, while a weak report may be favorable.
- Fixed income and currencies will give hints to how the market may open on Monday. This year, risk assets have generally rallied whenever data supported a possible moderation in central bank policy. Investors’ increased risk appetites explain why Bitcoin has surged 69% since the beginning of the year. Thus, a lower-than-expected jobs number could lead to an overall surge in equities on Monday. In the meantime, barring a significant event, we expect that markets will be relatively tame on the final trading day of the week.
The Saga Continues: The Washington and Beijing feud continues despite growing momentum for peace talks between Russia and Ukraine.
- A senior Ukrainian official has expressed his country’s openness to holding talks with Russia to end the territorial conflict. Prior to these comments, Ukraine President Volodymyr Zelenskyy dismissed the potential for talks until Russia removed all of its forces from his country, including Crimea. The change in sentiment is related to rising confidence that the Ukrainian military will be able to retake land along the administrative border of Crimea. The possible de-escalation of tensions between the two countries will be welcomed by Europe, who feared that Ukraine might overplay its hand if it tries to retake Crimea.
- Meanwhile, China is broadening its influence in the Middle East as Beijing positions itself to decouple from the U.S. On Thursday, government officials from Saudi Arabia and Iran met in Beijing for the first time since the countries agreed to restore diplomatic ties. The Chinese-brokered agreement reflects Beijing’s strategic pivot toward the Middle East and Africa as it looks to maintain its access to key raw materials. At the same time, U.S. Vice President Kamala Harris concluded her trip to Africa this week. She had one message to her African counterparts: America is your friend, and China is not.
- It is too soon to say whether the war between Russia and Ukraine is close to a conclusion. Both sides have much to lose if the conflict ends without a decisive victory for their respective side. That said, the end of the conflict could help ramp up the competition between the U.S. and China. The European Union’s deep trade ties with China have made it reluctant to completely sever ties with America’s top rival. French President Emmanuel Macron’s pestering of his Chinese counterpart to mediate tensions between Russia and Ukraine reflects Europe’s eagerness to maintain strong ties with China despite pressure from Washington. Hence, if Beijing is able to use its influence to end the war in Ukraine, EU countries may be less inclined to support U.S. trade restrictions.