The recent ADP jobs figure set a subdued tone, leading the market to anticipate a lacklustre non-farm payrolls report. However, the tables turned in November, with the non-farm employment numbers surpassing expectations. This unexpected surge of 199,000 jobs captured the attention and triggered a ripple effect across various financial indicators.
Bond Market Response
As is customary, the bond market responded promptly to the robust job figures. The 2-year yields experienced a substantial surge of 12.5 basis points, while the 10-year yields ascended by a noteworthy 7.6 basis points. A closer look at Fed Funds futures reveals a market-implied probability of rate cuts, projecting into 2024. Yet, the presence of 4.5 priced-in cuts before Christmas unveils a notable discrepancy.
Divergence Between Expectations
A significant disjunction persists between market expectations and the Fed dot plot for 2024. The dot plot indicates a median of 5.125%, in contrast to the futures market, hinting at Fed Funds concluding the year slightly above 4%. This raises questions about a potential error or deliberate misinformation by FOMC members regarding the trajectory of their policy rate decisions.
Powell’s Cautionary Notes
Fed Chair Jerome Powell and other speakers caution against unwarranted optimism on looser policy, signalling a retreat towards a higher-for-longer narrative. The equity markets, typically responsive to labour market strength, exhibited scepticism. The Dow Jones rose by 0.36%, and the NASDAQ, sensitive to duration, climbed by 0.45%. Mr. Market seems to be questioning the Fed’s assurances.
December FOMC Meeting Anticipation
The upcoming December FOMC meeting, as previewed by economist Philip Marey, will be crucial in understanding the Fed’s commitment to the higher-for-longer narrative. Sectors like commercial real estate and regional banks, laden with CRE risk, eagerly await this update. The thin line between disaster and calamity remains a concern, especially as office fund managers grapple with refinancing risk and rising vacancy rates due to the persistent work-from-home trend.
Financial Stability Risks
The looming financial stability risks are not lost on major Bank CEOs in the USA. During a Senate Hearing on December 6th, CEOs resisted the proposed implementation of the Basel III capital framework. Critics may label this resistance as self-serving, aiming for lower capital requirements to boost leverage and potential profits. Alternatively, senior bankers may resist being compelled to hold a greater volume of debt securities, subject to central bank manipulation.
Monetary Frameworks and Systemic Risk
Beyond a certain threshold, capital requirements forcing banks to acquire government debt at potentially off-market rates pose not only financial repression but also a source of systemic risk. As interest rates normalize, debts come due for refinancing, and bond portfolios incur substantial losses, this issue becomes more pressing.
Global Economic Landscape
This week, discussions around the more esoteric aspects of monetary frameworks and financial stability will take centre stage, not just in the USA but globally. Rate decisions are expected from the BOE, ECB, SNB, BCB, and the Norges Bank. While most are anticipated to maintain the status quo, the BCB stands out, considering its ongoing cutting cycle. Analysts project rate cuts in 2024, with the first cut now expected in June rather than September, though markedly less than market pricing.
Inflation Figures and Market Watch
Additionally, this week brings the release of CPI figures for the United States. Predictions point to further decline in headline inflation while core inflation remains resilient. Surprises, especially after China’s recent inflation numbers revealing accelerating deflation, will be closely watched. The soft landing scenario gains significance as the markets navigate through the week’s economic data.
In a landscape where economic data can sway markets, the unexpected surge in non-farm employment has created ripples, sparking debates on policy trajectories and stability. As central banks globally make pivotal decisions, and inflation figures come into play, the week promises intrigue for investors and analysts alike. Navigating through the surprises will be key to understanding the evolving economic tapestry.