Today’s podcast

Overview:  Shattered [Pivot] Dreams

• Payrolls too solid to support a pivot – ‘goods news is bad news’ strikes gain
• Equities fall sharply (S&P500 -2.8%), yields rise (US 10yr +5.8bps to 3.88%)
• USD stronger (DXY +0.5%), AUD hits new cycle low of 0.6355 now 0.6377
• This week: US CPI, FOMC Minutes, BoE Backstop, Earnings, China Leadership
• Coming up: quiet, JN Holiday, US Columbus Day (bond market closed, equities open)

“Woke up to reality; And found the future not so bright; I dreamt the impossible; That maybe things could work out right”, Johnny Hates Jazz, 1988

It was ‘good news is bad news’ for US Payrolls which were a touch better than expected and seen as too solid to support a pivot narrative. Headline payrolls were 263k vs. 255k expected, with only a small upward revision to the prior two months of 11k. Instead, markets reacted to the unemployment rate which fell two tenths to 3.5% vs. 3.7% expected, and to the participation rate which fell a tenth to 62.3% vs. 62.4%. The failure of the participation rate to rise will come as a disappointment to the Fed and to the ‘Fed pivot’ narrative. The one encouraging sign in the report was average hourly earnings which were as expected at 0.3%. Although annual wages growth at 5.0% y/y is still too high, the two-month annualised is running at 3.6% which is broadly consistent with at target inflation. Average hourly earnings is subject to significant compositional bias so it will be worth looking at the Atlanta Fed Wage tracker out later this week for an alternative read.

How will the Fed read this. The pretty much as expected read will keep the Fed on track for 75bps at the November meeting (markets are 94% priced for this). NY Fed President Williams, speaking after the release, said that the US has a very strong job market and that the Fed needs to raise rates to “somewhere around 4.5% over time”, with the timing and how high rates need to go depending on the data. At the September FOMC meeting Fed officials had pencilled in a cumulative 125bps for the rest of the year, which could be achieved by 75bps in November and 50bps in December. The WSJ’s Fed Whisper Timiraos broadly supported such an argument, noting the numbers “will keep the Federal Reserve on track to approve another large interest-rate increase at its meeting next month as officials” (see WSJ: Fed on Track for Another Large Interest-Rate Hike After Jobs Report).

Market reaction to payrolls was outsized for equities given sharp rally in equities earlier in the week. The S&P500 tumbled -2.8%, but still was up 1.4% on the week. The next big events for markets are the US CPI on Thursday and earnings season which kicks off in earnest with bank earnings on Friday (incl. JP Morgan, Wells Fargo, Morgan Stanley and Citigroup). On profit reporting worth noting FedEx’s Corp division warned delivery contractors in an internal memo that “we expect there to be downward adjustments to volume forecasts” with new forecasts available around 21 October, noting “ these changes will reflect the latest information from customers about how they anticipate current conditions are likely to decrease their volumes this holiday season”. The impact from the sharp appreciation in the USD over recent months will also be a theme.

Fed Funds pricing moved higher with a peak rate of 4.65% in March 2023 from 4.58% on Thursday. Note pricing for a 75bp move on November was already high at 72bps on Thursday, and now stands at 73bps. Yields rose with 2yr up 5.3bps to 4.31% and 10yr also up 5.5bps to 3.88%, meaning the 2/10s curve was broadly steady at -43bps. Real yields were little changed with the 10yr TIP yield at 1.61% and most the move was reflected in the implied inflation breakeven +6.0bps to 2.27%. The move in break-evens partly reflects oil with WTI up 4.7% to $92.64 as markets continue to digest OPEC+’s recent production target cuts and Russia states any price cap would see its production fall. Also likely impacting bonds was positioning ahead of the Monday Columbus Day holiday which sees bond markets closed, but equity markets open, and ahead of around $90bn in Treasury auctions later this week.

In FX the solid payrolls report gave support to the USD with DXY up 0.5%. Similar magnitudes of decline were seen among most pairs with EUR -0.7%, GBP -0.5%, AUD -0.6% and NZD -0.8%. USD/JPY (+0.3% to 1.45.33) was less moved given the threat of BoJ intervention should the Yen go meaningfully above 145. Note Japan celebrates its Sports Day Holiday today so it is unclear whether the MoF or BoK will be at home celebrating. The CAD also held its ground against the USD (USD/CAD -0.0%) supported by the Canadian employment report released at the same time as the US. Canada’s unemployment rate also fell 2 ticks to 5.2% vs. 5.4 expected, while headline jobs was broadly as expected at 21.1k. In terms of levels, its worth noting the AUD trading to a fresh 2½ year low of 0.6355 and currently trades around 0.6375.

Despite the solid payrolls report the Fed ‘will pivot’ narrative remains alive and it was curious in your scribe’s opinion the same WSJ Fed Whisperer who penned the above piece, also penned a weekend piece titled WSJ: Fed’s Inflation Fight Has Some Economists Fearing an Unnecessarily Deep Downturn. The piece quoted several former Fed officials calling on the Fed to slowdown the pace of rate hikes in order to buy time to see the economic effects of the considerable tightening put into place given the lagging nature of inflation. Should the Fed hike as expected, then the Fed would have put on 425bps worth of hikes in nine months and given no time to see how the economy reacts given monetary policy acts as a lag. Also doing the rounds on the ‘will pivot’ narrative is some notion that the financial system’s neutral rate may be lower than that for the real economy, which may mean it is not possible to see what potential severe financial market events may develop until it is too late. An interesting paper on this was a recent a recent one by the NY Fed: The Financial (In)Stability Real Interest Rate, R**. In this vein markets will be closely watching the scheduled end of the BoE’s gilt backstop on Friday.

Important weekend news included: (1) Russia/Ukraine where a truck bomb exploded on the Crimean Bridge causing two spans of the road bridge to partially collapse. The attack coincided with President Putin’s 70^th Birthday and it is unclear how Russia will respond to an attack on what it claims is Russian territory; (2) China’s Caixin services index which fell nearly 6 points in September to 49.3, as the zero-COVID policy and various lockdowns took their toll on the services sector. China’s COVID19 cases are on the rise again, to a five-week high, with evidence of community transmission in Beijing and Shanghai, ahead of the 5-yearly Leadership Congress that begins next weekend to re-elect President Xi.

Finally in Australian news, the RBA’s Financial Stability Review was published on Friday. The Review contained modelling on how sensitive households were if mortgage rates rose in line with market pricing (note this modelling was for variable rate loans which comprise around 65% of outstanding mortgage debt. Around a third of households have mortgages in Australia). The conclusion was that “overall, most borrowers are likely to be well placed to adjust their finances, with only a small share appearing vulnerable to falling into arrears”. However, three points are worth noting: (1) 15% of borrowers would see spare cash flow turn negative (i.e. repayments and essential living expenses exceeding income) if rates got this high; (2) under the scenario where households do not reduce non-essential real consumption, around 30% of borrowers would exhaust savings buffers within six months, while 55% of borrowers would not exhaust savings buffers for at least two years; and (3) the analysis did not cover fixed rate borrowers who now comprise around 35% of outstanding mortgage debt. Around 2/3rds of these loans are due to mature by the end of 2023 and will have to be refinanced at significantly higher rates – the spread relative to market pricing would imply these borrowers seeing a 3-4 percentage point rise in mortgage rates which would equate to a 40% rise in minimum repayments (see NAB’s write up: Households can service loans under the market cash rate path that sees the cash rate getting to 3.6% – RBA FSR).

Coming up this week:

• Australia: The NAB Business Survey for September will be released on Tuesday and headlines the week (no hints here). Also out the same day is the Westpac-Melbourne Institute Consumer Sentiment report for October. A record gap has emerged between consumer sentiment and business confidence, while there is also a very large gap between what consumers are feeling and what they are doing given strong retail sales data to date. The other data point worth watching is August Overseas Arrivals and Departures numbers on Tuesday to see whether net migration is accelerating as some other indicators may suggest (visas granted for foreign students and working holidays are near pre-pandemic levels). As for the RBA, Assistant Governor (Economic) Luci Ellis speaks on Wednesday.
• Offshore: The big events this week are the US CPI (Thursday), FOMC Minutes (Wednesday), the scheduled end of the BoE Backstop (Friday), Bank Earnings (Friday), and the Chinese Communist Party Meeting (Sunday).
  • US: CPI on Thursday the main game where focus is on the core measure after it printed at 0.6% m/m last month against numerous anecdotes of price pressures easing. This month the consensus is for 0.4% m/m. Risks seem to be for a lower print with again indicators suggesting some large falls in certain categories with the Manheim Used Vehicle Value index having fallen -4.0% in August and -3.0% in September. The pain trade for risk assets though remains to another upside surprise. Also out is Retail Sales and the University of Michigan Consumer Confidence Report on Friday. On the Fed front the FOMC Minutes are on Wednesday, along with numerous speeches with the most important being Governor Brainard on Monday where she is speaking to the NABE Economists’ Conference. Focus also on earnings with Wells, JP Morgan, US Bancorp, and Morgan Stanley on Friday.
  • CH: China returns from Golden Week holidays with a couple of data updates due in the week ahead of the 20th National Congress of the Chinese Communist Party which get underway on Sunday 16 October. At that Congress President Xi is expected to be elected to a historic third, five-year term. Focus thereafter will be whether China starts to pivot towards living with Covid and on any stimulus measures that may occur given the softness in the economy. In terms of data, Aggregate Financing data are due anytime, CPI/PPI is on Friday as is the Trade Balance.
  • UK: The long end of the gilt market continues at the centre of the market’s attention with the BoE backstop scheduled to end on Friday 14 October and QT also expected from 31 October. Markets are nervous. As for data, the pick will likely be Tuesday’s labour market report, metrics so far hanging in there, despite quickly emerging pressures. August GDP is also out Wednesday.

Coming up today (very quiet, holidays in Japan and US, only events are in Europe):

• CH: Markets are open: Markets open after the week-long holiday. Most focus on politics with the Chinese National Congress meeting on 16 October.
• JN: Sports Day Holiday: Markets are closed.
• EZ: Sentix & ECB Speak: Investor confidence is expected to remain subdued at -34.7. There are three ECB speakers, including Centeno, de Cos and chief economist Lane.
• US: Columbus Day Holiday: National Holiday which sees the bond market closed but the equity market open. Note Canadian markets are closed for Thanksgiving, which they observe earlier than the US.

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