Risks to stock market bounce keep coming

Summary

Resumed risk appetite will be tested again shortly.

Payrolls boom, stocks barely flinch

Strongly committed or not, buyers who stepped in on hopes of a reassuring Fed signal, have made it into the second half of Europe’s session, taking ambivalent implications from blockbuster payrolls in their stride. An outbreak of more promising geopolitical news, after several dark weeks on the global economic and market fronts, is holding sway. News of second-tier trade talks and better-than-forecast Chinese service industry data lifted the gloom early. China then remained in focus after its central bank issued its latest incremental reserve requirement ratio cuts for banks. The ‘risk’ upswing still sees principle European indices up by 1.5%-2% and Wall Street similarly buoyed. Trusted weathervanes, like a rise in Treasury yields, slips by the yen and gold, also remain corroborative, despite the strongest set of U.S. payrolls in 10 months and hourly earnings growth that also beat forecasts, underscoring the probability that consumption and inflation are likely to keep the economy running in top gear for many more months yet.

Tell-tale Treasury yields

Worth noting: whilst the 2-year yield was extending its bounce just now, to almost 11 basis points, from a first print below the Fed’s effective fund rate since 2008, the 10-year yield rose by a not too dissimilar 9.3bp from one-year lows. The moves essentially keep the curve between the two as flat as before. Accordingly, the traditional indication of a U.S recession, from the flattening 2s/10s curve is little-changed as another critical risk event approaches. We interpret the yield shuffle as the bond market reserving judgement about the chances of a market-pleasing inflection point from the Federal Reserve. As for riskier markets, barely moderated post-payrolls stock market gains suggest investors continue to price in a Fed pause. Indeed, Fund futures now project a higher probability that the Fed will cut this year than odds of a hike. That’s the crux of risks to sentiment for the last trading day of the first week in 2019.

Powell up next

Market hope still looks discordant with Fed guidance. Anticipation has been further heightened by comments from Dallas Fed president Robert Kaplan on Thursday, and his Cleveland Fed counterpart Loretta Mester earlier today. Kaplan outright called for a pause in hiking. Mester, a recognised hawk, pointed to “downside risks” whilst characterising current policy as in “a good spot”. Fed chairman Jerome Powell will shortly have an opportunity to agree or disagree. He will be accompanied at a symposium in Atlanta by QE-era chairs Yellen and Bernanke. With markets still tightly wound, a pro-risk misinterpretation is possible. On the other hand, what is known about Powell thus far suggests little proclivity to change tack speedily. Instead, he could largely reiterate a view that tightening will continue on a gradual, data-dependent path, backed by continuing evidence that the economy is strong enough to take it (see December payrolls). That would not be what markets want to hear.