The weekender: Goldilocks with a rider clause

Markets

US stocks traded significantly higher Friday, riding the updrafts from a debt ceiling deal and a likely Fed pause. And we kicked June off in glorious fashion as big US data may be pointing to a 'Goldilocks' scenario again of 'not too hot/not too cold' activity -- and could still play nicely to the 'skip' crowd within the FOMC despite the blow-off top in the headline NFP report.

But in no small part, investor enthusiasm about the potential benefits to companies from AI has helped lift the index to 4289 (+12% YTD) despite uncertainty on the timing and magnitude of the adoption of AI.

There is no use hiding the lead in; the NFP report was persuadable to the ‘Goldilocks’ crew as the blow-off top headline was accompanied by a downtick in the monthly pace of wage growth, a slightly more relaxed than expected read on YoY average hourly earnings and a meaningful uptick in the jobless rate to 3.7 % from 3.4 %. And in any historical context, favourable for a soft-landing

Now the rider clause; the household survey showed a 310,000 decline—the largest in 13 months. The number of unemployed rose to 440,000, the largest since 2020.

Although disparities between the headline NFP and the household survey are hardly rare, they tend to attract much more attention at critical economic turning points.

But of course, you can spin that in any way, especially as a positive development, mainly because the weaker household survey takes the highly sharp edge off another NFP blockbuster headline beat.

But last week was really about Fed speak as it became self-evident that the Hawks would not prevail at this upcoming FOMC meeting absent a massive beat in the May CPI report. Thanks to an uptick in the employment rate, an in-line average hourly earnings print and ambiguity introduced by the decline in the household survey, so as strong as the headline NFP was, it won’t tip the scales back a June hike.

The US debt limit issue resolution further solidified the Goldilocks environment as the House and the Senate passed the deal reached between the White House and House Speaker McCarthy last weekend. The deal should curb GDP growth by 0.1%-0.2% per year for the next 2 years, and combined with the growth-suppressing impulse from the residual effects of the March regional banks turmoil, we should have enough uncertainty to keep the Fed at bay for a bit.

We expect the grind from here to be choppy: a typical 3-5% pullback is due even more so as the market narrative on the debt ceiling shifts from the risk of default to the risk from its resolution on liquidity withdrawal concerns.

But on a more favourable note, while pickups in inflation and rate expectations remain a source of vol, the impact should be much smaller in magnitude than last year; hence the tide is turning as fewer investors expect a significant risk aversion selloff around what is the most well-telegraphed potential recession ever. And after 18 months of bear trap talk, perhaps the bears have been caught in their own traps.

While manufacturing historically dominates the business cycle, and its weakness would typically be associated with an encroaching recession, the opposite read is probably more credible, namely that services are so so strong that a widespread recession is less likely, especially since manufacturing may have limited downside from these already weak levels.

China

Yet another contrived and forced relief rally ensued in Asia markets after China regulators were reportedly considering reducing the down payment in some non-core neighbourhoods of major cities, lowering agent commissions on transactions, and further relaxing restrictions for residential purchases under the guidance of the State Council.

I honestly don’t think this will pass the test of time, given that China’s lacklustre returns can easily be grouped into a few categories that continue to suggest more downside for the economy.

The First concerns the sustainability and magnitude of the post-Covid recovery, prompted by the disappointing macro data in April and the softening momentum of some high-frequency indicators in May.

Second, high government leverage and constrained fiscal capacity amid falling land sales reduce the possibility for more potent policy stimulus, which could help extend the growth cycle and revive confidence in the economy and capital markets.

Externally, global geopolitics and US-China tensions have continued to trigger debates around the viability of investment in Chinese assets, and the widely-expected endorsement of the "reverse CFIUS" order by the White House shortly could further complicate the portfolio flows, equity sponsorship, and perceived cost of equity dynamics for the stock market.

Last but not least, well-telegraphed structural headwinds, including high leverage, aging demographics, high youth unemployment, housing market deflation, technology bottlenecks, and regulatory stance towards the private economy are still key sentiment overhangs, continuing to challenge investor confidence in China's long-term growth prospects.

Forex markets

So then, why did the US dollar rally? For no other reason than the + 300,000 NFP headline would play more to the hawkish wing within the FOMC, and at a minimum, the thought of an entire 25bp hike would eventually be priced between June and July lends support to the dollar.

There were reports yesterday that some Chinese cities are considering easing property policy, and USD/CNY has moved lower. There is a big difference for FX whether looser policy comes from monetary (FX negative) or property or credit easing (FX positive). The degree to which the slightly forced Yuan rally sticks is debatable based on the market’s sub-optimal China growth outlook.

Oil markets

Government figures released earlier this week showed domestic oil production declined by 100,000 barrels per day (bpd) during the final week of May to 12.2 million bpd -- still 900,000 bpd below the pre-pandemic high recorded in February 2020.

The dwindling recovery in the U.S. oil patch, coupled with a still-resilient labour market, could force the hand of OPEC+ ministers to push back against another production cut touted by Saudi Arabia. As of Friday afternoon, most market participants expect the group to keep production quotas unchanged at their Sunday meeting after cutting collective oil output by nearly 3.5 million bpd since October 2022.

Saudi Arabia wants higher oil prices, in the $80s range, to finance its flights of fancy. While Russia, on the other hand, has made it abundantly clear they have very little desire to be compliant after it captured considerable market share from Saudi Arabia by selling cheap oil to Asian consumers.

However, the good news on the broader market extended the oil market rally on Friday as energy traders received the best of both worlds in the modern-day Goldilocks playbook, with the NFP headline coming in strong with wages easing. Hence, the data mix combination doesn’t meet the bar for a Fed hike.

But more importantly for oil markets, fewer folks expect a recession soon, with the strong global services sectors expected to offset the weakness in the languishing global manufacturing areas.