Weekly Comment: Strong US jobs data dashes Fed pivot hopes

Global stock markets gained last week, with the MSCI All Country World Index ending up by 1.8%. Growing optimism of a forthcoming pivot from the Federal Reserve (Fed) had sent equities significantly higher than where they ended, although these hopes were somewhat dashed by another solid US jobs report, which caused selling into the weekend and saw stocks pare the majority of their gains.

Still, US large-cap benchmarks posted a weekly gain for the time in four weeks, ending up by around 1.6%. A softer than expected ISM manufacturing purchasing managers’ index report, containing encouraging signs on price pressures, and news that job openings had fallen to their lowest level in a year sparked hopes that the Fed may opt to slow rate hikes, sending US indices up by more than 5% early last week, for their best two-day rally since 2020.

However, this growing sense of optimism was curbed as the week wore on, first by a sharp move higher in the oil price after OPEC+ announced a 2 million barrel a day cut in production targets, and, more importantly, on Friday by the September labour market data. While the US added slightly more jobs than expected last month (263,000 vs 248,000 expected) the most damaging parts of the Labour Department report for equities were the unemployment rate falling back to multi-year lows of 3.5%, down from 3.7%, and an unexpected drop in the participation rate, to 62.3%.

Simply put, there was very little here that could be seen to weigh on Fed decision making in favour of a more dovish approach when the rate-setting committee convene at the start of next month, with another 75 basis point increase still widely expected. A move of this increment would take the benchmark policy rate to 4.0% and derivatives markets are currently pricing a further increase to 4.5% by year-end.

US treasury yields moved higher at the end of the week following the release of the labour market data, as equities pulled back. The US 10-year yield ended higher by five basis points at 3.88%, after trading below 3.60% at one point as the Reserve Bank of Australia delivered a smaller than expected 0.25% rate increase. The low for yields coincided with a two-week low for the US dollar, although the greenback recovered to end the week higher.

More support

The Bank of England (BoE) has announced additional measures to protect pension funds and provide further ballast to UK financial markets after recent bouts of extreme volatility following chancellor Kwasi Kwarteng’s “mini-budget”. The central bank has loosened the rules for its £65bn bond-buying scheme and declared longer-lasting measures in an attempt to head-off any wild market swings when its preliminary support was due to end on Friday 14th October. The chancellor has also announced that his medium-term fiscal plan will be brought forward by just over three weeks to 31st October.

The sharp move higher in UK government bond yields after the “mini-budget” forced pension funds into rapidly selling assets to meet liquidity needs, placing a great strain on the market. The new BoE measures include a doubling in the permitted size of daily gilt purchases to £10bn, even though a cumulative total of £4bn was purchased during the first eight days of the operation. Last week the UK 10-year gilt rose by 15 basis points to 4.23%.

The BoE’s Monetary Policy Committee is now expected to raise the base rate by 100 basis points at each of its two remaining scheduled meetings for 2022, according to derivatives markets. This would leave the benchmark policy rate at 4.5% by year-end and further increases are being priced in, with the rate expected to rise to 5.75% by June.

UK large-cap benchmarks underperformed their US and European equivalents last week, despite energy, which the UK has a greater weighting towards, being the standout sector. The OPEC+ cuts triggered a rally in the oil price with international benchmark Brent Crude rising nearly 15% to end the week just shy of the US$100/barrel mark – its highest level since August.

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