US Jobs Report Provides Comfort For Markets

The US June jobs report released on Friday provided plenty of comfort for US equity markets. Non-farm payrolls rose by an above consensus 850,000 while the unemployment rate ticked higher to 5.9% from 5.8%.  The strong increase in payrolls helped US equities close out another week in positive mood; S&P 500 rose 0.75% and the Nasdaq gained 0.81% as investors continued to pile back into growth stocks. US Treasury bonds were supported, helped by an increase in the unemployment rate, while the US dollar fell.

Despite the jobs gain, payrolls are still around 6.8 million lower than pre-Covid levels, suggesting a long way to go for a full recovery. Federal Reserve officials will likely need to see several more months of jobs market improvement to achieve their “substantial further progress” tapering criterion.  Overall, the data played into the Fed’s narrative that tapering is still some way off and higher US interest rates even further away, leaving little for markets to fret about.

OPEC+ tensions between Saudi Arabia and UAE have increased, delaying OPEC+ talks to today against the background of oil prices pushing higher above $75 per barrel.  Riyadh along with other OPEC+ members appear keen to increase production over coming months while the UAE supports a short term increase, rather than the end of 2022 which other OPEC members are looking for.

Markets activity is likely to be subdued at the start of the due to the US holiday and there seems to be little to break out of the low volatility environment that we are currently in the midst off, though the US dollar will look to extend recent gains against the background of persistent short market positioning as reflected in the CFTC IMM data.  

This week attention will turn to the Federal Reserve FOMC Minutes of its last meeting (Wed), ISM non-manufacturing survey (Tue), and central bank policy meetings in Australia (Tue) and Poland (Thu) alongside Chinese June inflation (Fri) and credit aggregates data (from Fri). 

Given the sharp market reaction following the less dovish Fed FOMC meeting, markets will look for any further elaboration on the potential timeline for tapering in the Fed Minutes.  While both the RBA in Australia and NBP in Poland are likely to stay on hold, the RBA is likely to strike a dovish tone in its statement and Q&A while the NBP is likely to announce a new set of economic projections.  No shocks are expected from China’s June CPI inflation reading, though producer price inflation, PPI is likely to remain elevated.

A Better Start To The Week

The start of this week looks somewhat better compared to the end of last week. Although nervousness will remain amidst thinning liquidity, news that the UAE central bank “stands behind” local and foreign banks and will lend, albeit at a rate of 0.5% above the 3-month benchmark rate, will reassure investors that banks have sufficient liquidity in the wake of any losses suffered due to the Dubai Holdings debacle. This will see some improvement in risk appetite.

The news will unlikely prevent stock markets in the UAE, which open today following Eid holidays, from sliding, however. Attention will turn to the suspended Sukuk bonds and also to the extent of support (and any strings attached) provided by Abu Dhabi to Dubai. The support from the central bank will help markets outside of the UAE regain a little composure and limit demand for safe haven assets but the rally may prove limited until there is greater transparency.

Nonetheless, even if there is some relief at the beginning of this week due to some containment of the problems in Dubai nerves are likely to fray going into the end of the year, with the multi-month trend of improving risk appetite faltering. There have been plenty of reasons for markets to worry lately including concerns about the shape of economic recovery in the months to come as well as renewed banking sector concerns and these will not be allayed quickly.

Data this week in the US is unlikely to help to dampen growth concerns. The main event is the US November jobs report and although the magnitude of job losses is set to decrease the unemployment rate is set to remain stubbornly high around 10.2%. In addition to an expected decline in the November ISM manufacturing index suggests that growth concerns will intensify rather than lessen. This in turn highlights that any improvement in risk appetite this week will prove limited.

The other key events this week include interest rate decisions in Europe and Australia. Although the ECB is widely expected to leave rates on hold on Thursday, there will be plenty of attention on any details of the Bank’s “gradual” exit strategy. Whether the ECB offers new loans to banks at a variable interest relative to the current fixed rate will be taken as an important sign on the path of liquidity withdrawal. We believe the Bank will stick with a fixed rate. The RBA will take a step further and announce a 25bps interest rate hike tomorrow.

FX markets are likely to be buffeted by the gyrations in risk appetite but at least at the beginning of the week the USD is set to give up its recent gains, with EUR/USD likely to try and hold above 1.5000 as markets digest the better news coming from the UAE. The JPY will be a particular focus given the growing attention of the authorities in Japan. Finance Minister Fujii is quoted in the Japanese press that they won’t intervene in the FX market, which appears to give the green light to further JPY strength though I suspect that if USD/JPY drops below 85.00 again there will plenty of FX intervention speculation and in any case these comments have since been denied.

Dubai’s aftermath

Dubai’s bolt out of the blue is hitting markets globally, with the aftershock made worse by the thin liquidity conditions in the wake of the US Thanksgiving holiday and Eid holidays in the Middle East.  The sell off followed news by government owned Dubai Holdings of a six month debt freeze.  Estimates of exposure to Dubai vary considerably, with European banks estimated to have around $40 billion in exposure though what part of this is at risk is another question. 

The lack of information surrounding the Dubai announcement made matters worse.  The aftermath is likely to continue to be felt over the short term, with further selling of risk assets likely.  Indeed, there is still a lot of uncertainty surrounding international exposure to Dubai or what risk there is to this exposure and until there is further clarity stocks look likely to face another drubbing.

The most sensitive currencies with risk aversion over the past month have been the JPY, and USD index, which benefit from rising risk aversion whilst on the other side of the coin, most Asian currencies especially the THB and KRW as well as the ZAR, and AUD look vulnerable to any rise in risk aversion.  JPY crosses look to be under most pressure, with the likes of AUD/JPY dropping sharply and these currencies are likely to drop further amidst rising risk aversion. 

The rise in the JPY has been particularly dramatic and has prompted a wave of comments from Japanese officials attempting to talk the JPY lower including comments by Finance Minister Fujii that he “will contact US and Europe on currencies if needed”.  So far, these comments have had little effect, with USD/JPY falling briefly through the key psychological level of 85.00, marking a major rally in the JPY from a high of 89.19 at the beginning of the week.  Unless markets believe there is a real threat of FX intervention by Japan the official comments will continue to be ignored.

It’s not all about risk aversion for the JPY, with interest rate differential playing a key role in the downward move in USD/JPY over recent weeks.  USD/JPY has had a high 0.79 correlation with interest rate differentials over the past month.  The US / Japan rate differential narrowed sharply (ie lower US rate premium to Japan) to just around 4.5bps from around 100bps at the beginning of August.  With both interest rate differentials and risk aversion playing for a stronger JPY the strong JPY bias is set to continue over the short term.

Is this the beginning of a new rout in global markets?  It is more likely another bump on the road to recovery, with the impact all the larger due to the surprise factor of Duba’s announcement as it was widely thought that Dubai was on the road to recovery.  The fact that the news took place on a US holiday made matters worse whilst the weight of long risk trades suggests an exaggerated fall out over the short term.

%d bloggers like this: