By Saqib Iqbal Ahmed and Lewis Krauskopf
NEW YORK (Reuters) – The resonance of a booming U.S. employment figure could threaten a series of trades based on falling interest rates, as stronger-than-expected growth prompts investors to change their view on how much the Federal Reserve will need to radically change austerity. costs in the coming months.
Expectations of steep interest rate cuts have fueled bets in recent months on everything from rising government bond prices to a weaker dollar, while corners of the stock market such as utilities have been squeezed. The Fed made a massive 50 basis point cut last month, temporarily confirming this view.
But the path in interest rates is less certain after Friday’s labor market report, which showed the U.S. economy created more than 100,000 more jobs than expected last month. That signals less need for more big cuts this year and raises the prospects for a turnaround in many of the deals that relied on lower interest rates.
Futures linked to the fed funds rate showed on Friday that traders had ruled out another 50 basis point cut at the central bank’s November meeting. According to CME FedWatch, the market price on Thursday reflected a greater than 30% chance of such a cut.
Here’s a look at some corners of the market that could be affected by a rate reset.
DOLLAR REBOND
Net bets on a weaker dollar reached $12.91 billion in futures markets last week, the highest level in about a year, data from the Commodity Futures Trading Commission showed, after the dollar posted its worst quarter in almost two years.
But the dollar shot to a seven-week high against a basket of currencies on Friday and could post further gains if bearish investors are forced to call off their bets.
“The dollar bears undoubtedly took their skis too far this week and are now suffering the consequences,” said Karl Schamotta, chief market strategist at payments firm Corpay in Toronto.
REVERSAL OF THE TREASURE MAPS
The bets on a stronger-than-expected economy could also accelerate a recent recovery in government bond yields. Yields on the 10-year U.S. Treasury note, which move inversely to bond prices, hit a 15-month low of 3.6% in September as investors rushed to price in rate cuts.
That movement has reversed in recent days. According to the figures, interest rates reached 3.985% on Friday, the highest level in about two months.
Zhiwei Ren, portfolio manager at Penn Mutual Asset Management, said the jobs report was a big surprise that went against the “consensus and busy trading” in the government bond market, which had been banking on bond prices rising as yields continued to fall.
HEDGE QUESTION
Expectations of economic strength may also prompt investors to shift their focus from option hedges to further gains in the stock markets, giving the S&P 500 more upside potential, said Charlie McElligott, managing director of cross-asset strategy at Nomura.
As investors look to the upside, “it could quite rationally act as fuel for the melt-up to 6,000 and beyond,” he wrote. That would mean a gain of about 4%.
In options markets, several measures of skew — a measure of the relative demand for downside protection versus upside speculation — have remained elevated after reaching their highest levels of the year during an August stock sell-off, even as the S&P 500 rallied.
The benchmark stock index rose 0.9% on Friday to end at 5,751.07, near a new high.
“The higher figure after the huge Labor figure tells you that people don’t have the right tail,” McElligott said, referring to the possibility of an extremely large rise in share prices.
However, a countervailing force in the short term could be too much of a rise in yields, which could reduce the attractiveness of stocks versus bonds, Jeffrey Schulze, head of economic and market strategy at ClearBridge Investments, said in a note Friday. The ten-year interest rate is still about 100 basis points below the level of a year ago.
“However, this release should be positive for risk assets in general and for US equities in particular in the medium term, as expectations for economic growth should improve following today’s release,” he added.
DAY TO BOND PROXIES?
Investors may also need to reconsider trading certain stock sectors, which have been favored as yields fell.
These include the market’s bond proxies, high-dividend stocks from sectors that had become popular with income-seeking investors as yields fell. One of those sectors, the utilities sector in the S&P 500, is up 28% this year, compared to a 20.6% gain for the S&P 500.
“The economy may not be in as much trouble as people were concerned about, and may not need these big rate cuts that have fueled interest in the higher-yielding parts of the market,” said Robert Pavlik, senior portfolio manager at Dakota Wealth. .
(Reporting by Saqib Iqbal Ahmed and Lewis Krauskopf in New York; additional reporting by Davide Barbuscia in New York; Editing by Ira Iosebashvili and Matthew Lewis)
