Written by Saqib Iqbal Ahmed and Louis Krauskopf
NEW YORK (Reuters) – U.S. payrolls will explode if stronger-than-expected growth causes investors to fundamentally change their view of how much the Federal Reserve needs to cut borrowing Expenses that will be incurred in the coming months may threaten various transactions based on the assumption that interest rates will fall.
Expectations for deep interest rate cuts have spurred bets on everything from higher U.S. bond prices to a weaker dollar in recent months, energizing sectors of the stock market such as utilities. That view was briefly vindicated last month when the Fed cut interest rates by a whopping 50 basis points (bp).
But the trajectory of interest rates is less uncertain following Friday’s labor market report, which showed the U.S. economy creating more than 100,000 more jobs than expected last month. This suggests there is less need for another deep rate cut this year, raising the possibility that many of the trades that were tied to lower rates will be reversed.
Futures linked to the federal funds rate on Friday showed traders were ruling out the possibility of another 50 basis point rate cut at the central bank’s November meeting. Market prices on Thursday reflect the probability of such a rate cut being more than 30%, according to CME FedWatch.
Here we introduce some of the markets that may be affected by the interest rate review.
dollar rebound
Net bets on a weak dollar in futures markets last week totaled $12.91 billion, according to data from the Commodity Futures Trading Commission, as the dollar hit its worst level in nearly two years. It was the highest standard ever.
But the dollar hit a seven-week high against a basket of currencies on Friday and could rise further if bearish investors are forced to exit their bets.
“Dollar bears have definitely gotten too excited this week and are now suffering the effects of that,” said Carl Schamotta, chief market strategist at payments firm Kopay in Toronto.
Treasury reversal
Bets on a stronger-than-expected economy could also accelerate the recent recovery in U.S. Treasury yields. The yield on the benchmark 10-year Treasury note moved inversely to bond prices, hitting a 15-month low of 3.6% in September as investors raced to price in a rate cut.
This trend has reversed in recent days. The data pushed the yield to 3.985% on Friday, the highest level in about two months.
Ren Zhiwei, a portfolio manager at Penn Mutual Asset Management, said the jobs report reflected a “consensus and crowded trade” in the U.S. Treasury market, which had been betting that bond prices would rise as interest rates fell further. He said it was a big surprise.
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hedging demand
Charlie McElligott, managing director of cross-asset strategies at Nomura, said expectations for a strong economy could push the S&P 500 higher as investors move away from option hedging to chase further gains in the stock market. That’s what it means.
As investors chase the upside, “it could very reasonably act as fuel for a crash above $6,000,” he wrote. This is a profit of about 4%.
In the options market, despite the S&P 500’s recovery, skew (a measure of the relative demand for downside protection and upside speculation) has fluctuated since August’s sell-off hit its highest level this year. The scale is still rising.
The benchmark stock index rose 0.9% on Friday to close at 5,751.07, near a new high.
McElligott noted the potential for very large stock price increases, saying, “The rise in stock prices after a big labor data ‘win’ shows that people don’t have a ‘right wing.'” said.
However, Jeffrey Schultz, head of economic and market strategy at ClearBridge Investments, said in a note Friday that a sharp rise in yields could offset this in the short term, potentially making stocks less attractive relative to bonds. He said there is. The 10-year Treasury yield remains about 100 basis points below where it was a year ago.
“However, economic growth expectations should improve following today’s announcement, so this should be positive for risk assets in general, and US equities in particular, over the medium term.”
Are you done binding proxies?
Investors may also need to reconsider trading in some equity sectors that have benefited from lower yields.
That includes the market’s fixed-income proxies, as well as high-dividend stocks in a sector that has become popular with income-seeking investors as yields fall. One such area, the S&P 500’s utilities sector, is up 28% year-to-date, compared to a 20.6% gain for the S&P 500.
“The economy may not be in as much trouble as people feared, and these deep interest rate cuts that have increased interest in the higher-yielding parts of the market,” said Robert Pavlik, senior portfolio manager at Dakota Wealth. It may not be necessary.” .
(Reporting by Saquib Iqbal Ahmed and Louis Krauskopf in New York; Additional reporting by Davide Barbusia in New York; Editing by Ira Iosebashvili and Matthew Lewis)
