SUMMARY: MNI highlighted a St Louis Fed model, based on data Homebase, that indicates employment increased +585k in August. Consensus for headline payroll is +300k. A Payroll reading in the +500 range would solidify 75bps in September – markets are currently pricing in ~70% odds of 75bps, and send rates higher across the curve. Terminal rate expectations would increase too. 10yr yields, which have already had a 91st percentile m/m move would increase significantly on a very strong payroll report, and yield curves would flatten. Also keep in mind that the Fed’s urgency to slow economic growth would increase on a very strong payroll reading, which will ultimately limit how high 10yr yields would go. Especially if the longer-term growth outlook for the economy is still in the 1.8% range.
We remain long Defensives, Low Volatility factors, and Quality (all have worked) while near-term economic growth remains too strong, indicating tighter financial conditions are needed to slow inflation.
We are inclined to be the long the 10yr (short yields) after a mechanical increase in rates following a hot employment report. And if the Payroll report misses, we would be long 10yr. The 10yr tends to track PMIs and overnight, global PMIs indicated further weakness in goods and services. A new top in 10yr yields is likely coming in the next month or so.
Headlines are dominated by China’s lockdown of Chengdu, a city of 21 million. Chengdu is not on the list of manufacturing hubs Victor Shih told us to monitor in a webinar we hosted with him earlier this year (replay HERE), but reiterates China’s commitment to COVID zero. There was supply-driven deflation last month, per a model run by the SF Fed (HERE). Persistent, widespread lockdowns jeopardize the easy disinflation in goods (the sticky parts of inflation will remain too high) that is setting in now, and we doubt the China lockdown news will change that. China needs to keep exports flowing to avoid an economic catastrophe.
John Roque recommends shorting semis. A Quant report last Friday (HERE), showed that semis negative correlation to higher implied equity volatility and tighter financial conditions. Semis have poor exposure to Low Vol, leaving them vulnerable to more tightening.
Within tech, a tilt toward lower Vol Tech – mega caps over smaller more speculative names – continues to make sense. While most of Tech tends to have higher volatility, we list S&P Tech names in the S&P 1500 that fall into the top quintile Low Volatility basket in the full report. We highlight the short list as well. See below…
MARKET VIEWS: MNI highlighted the St Louis Fed has a model forecasting a strong employment growth in August (+585k, consensus is for +300k). A blowout Payroll reading would solidify 75bps in September – markets are currently pricing in ~70% odds of 75bps. Terminal rate expectations would increase as well. Strong labor data would also imply near-term recession risk is low. Both would be a tailwind to the 10yr yield, which has already had a 91st percentile m/m move.
If a higher fed funds path means a sharper slowdown and more recession risk longer out, the 10yr would fall. We would be the long the 10yr (short yields) after a mechanical increase in rates following a hot employment report. FYI, traders are positioned for more yield increases.
Overnight news was dominated by China’s lockdown of Chengdu, a city of 21 million. Chengdu is not on the list of manufacturing hubs Victor Shih told us to monitor in a webinar we hosted with him earlier this year (replay HERE) but reiterates China’s commitment to COVID zero. Global PMIs, released overnight, already indicate further weakness in goods and services. The 10yr tends to track deterioration in the PMIs, consistent with our point above that we would be long the 10yr (short yields) after a mechanical increase if Payrolls are strong.
The Fed is committed to dealing with inflation. Persistent or higher supply-driven inflation would mean the Fed has to bring down demand-driven inflation more aggressively. This is not our call, but helps explain the market sensitivity to lockdown headlines. There was supply-driven deflation last month, per a model run by the SF Fed (HERE). Persistent, widespread lockdowns jeopardize the easy disinflation. We aren’t there yet though.
SEMIS: John Roque recommends shorting semis…
A quant report last Friday (HERE), showed semis are negatively correlation to higher implied equity volatility and tighter financial conditions. Semis have poor exposure to Low Vol, leaving them vulnerable to more tightening.
Within tech, a tilt toward lower Vol Tech – mega caps over smaller more speculative names – continues to make sense. While most of Tech tends to have higher volatility, below we list S&P Tech names in the S&P 1500 that fall into the top quintile Low Volatility basket. Tightening of financial conditions brings the strongest, most consistent tailwind to Low Volatility names.
The short list below are S&P 1500 Tech names falling in the high Liquidity basket that should face more headwinds during the tightening of financial condition.
