Asia open insights: Pre-NFP rate cut buzz continues to dominate conversations

Markets

US stocks are trading modestly higher Thursday, led by outperformance in tech stocks (GOOGL is up over 5%), as investors position ahead of Friday's payrolls report and on the back of a series of benign employment data.

The forthcoming jobs report is expected to be a significant factor, but its expectations to convey a strong or hawkish message have been set relatively high. Given the risk-friendly tone from a series of tier 2 employment data, it would be challenging to interpret the report as hawkish unless it delivers a blockbuster-type number.

Investor interest in Artificial Intelligence (A.I.) has regained prominence, particularly with the notable outperformance of Alphabet Inc. (GOOGL) and Advanced Micro Devices (AMD) following their AI-related events on Wednesday. The positive developments in A.I. have played a pivotal role in the remarkable surge witnessed in the seven most extensive stocks of the S&P 500. This trend has significantly shaped the aggregate index's overall returns and valuation direction throughout the year.

However, in the more recent period, the S&P 500's upward movements have coincided with a notable outperformance of cyclical stocks compared to defensive ones, especially in response to the decline in interest rates.

Arguably, folks are just boarding the 2024 Market Mystery Tour Bus with many policy and economic questions needing to be answered before investors are willing to signal the all aboard.

One pressing question at hand, or rather the dual nature of it, revolves around how market participants will react to slowing growth and a softer U.S. labour market. Will they welcome these developments due to the implications for inflation (cooling down) and the potential for easier monetary policy? Alternatively, will the negative news be interpreted as confirmation of various recession warnings?

Fed rate cuts have returned to the forefront. Having embraced rate cut fever, which has led to some asset price overshoots, this week's gold moonshot, for example, translating the benign rates view into a sustained positive market outlook amid valuation concerns and the potential delay in rate cuts by the Fed leaves investors prone to setbacks. Essentially, the further investors run with the rate cut baton, the more vulnerable they become to more robust economic data or a Fed pushback.

Despite the current situation not necessitating a shift to a cautious view or short positions, these challenges merely highlight the need for caution and the potential for market vulnerabilities.

In the past two weeks, there has been a notable shift in focus towards the potential for Fed rate cuts, even in the absence of a recession. Governor Waller's comments revived the idea of "adjustment" cuts, where the Fed considers lowering the funds rate due to declining inflation. This notion, which seemed to fade in September, has influenced market pricing for the 2024 funds rate outlook, with 130 basis points of cuts now factored in.

While the market is adopting a more dovish stance, my central view remains skeptical about the extent of easing, projecting around 75 basis points of cumulative easing without a significant growth downturn. A recession might justify a deeper easing cycle, but current asset prices and my central case don't align with such a scenario. Consequently, I think the market may find it challenging for U.S. rates to rally unless the growth outlook deteriorates more than anticipated; investors have shifted the discussion toward the timing, magnitude, and pricing pace of easing.

While the rally in speculative areas might not concern policymakers yet, the data remains a significant risk, particularly if upcoming releases, such as solid payrolls and lower unemployment rates, challenge the current market narrative.

The FOMC dots next week, showing two or more cuts for 2024, could fuel speculation about early easing, primarily if Chair Powell provides less forceful pushback. However, the market's pricing of more aggressive easing profiles introduces a balance of risks around the meeting.

Though generally given a lower weight these days after the Treasury issued lower coupon size, bond supply concerns may influence back-end rates as the issuance calendar picks up.

On the bullish end of the 2024 Market Mystery Tour Bus, The potential impact of robust growth data leading to increased rate pricing would differ from earlier periods this year. Previous concerns revolved around skepticism about policymakers' ability to bring down inflation without aggressively tightening rates and causing a recession. However, the current situation is less pressing, with core inflation hovering near targets sequentially and subdued commodity price pressures. Equities might have more room to respond positively to robust data and higher rates. The critical factor for equities is the belief that the Fed will adopt a dovish stance if growth disappoints, essentially providing a "Fed put."

The endorsement of non-recessionary or adjustment rate cuts would further bolster stocks. This dovish scenario enhances the likelihood of sustained small-cap outperformance, as non-recessionary rate cuts tend to benefit areas with weaker balance sheets impacted by tighter policy. Beyond the U.S., emerging market (E.M.) assets, which have exhibited strong performance recently, are likely to continue their upward trajectory. The potential for non-recessionary cuts in the U.S. may pave the way for more substantial cuts across E.M., attracting fund flows to robust E.M. stories if the U.S. front end presents a lower hurdle.

Despite a decent rally on Wall Street, Asian stocks are poised for an early decline on Friday as traders increasingly speculate that the Bank of Japan (BOJ) is nearing the end of its negative interest rate policy ( NIRP). With the Yem surging, futures contracts in Japan have predictably declined, as exporters recoil. And shares across the regions are slipping as investors exhibit a cautious stance ahead of the US payroll data.

Traders have ears and eyes trained for any clarification from BOJ Governor Kazuo Ueda after his recent remarks suggested a more challenging environment, fueling speculation of a possible end of NIRP.

Despite a 1% slip the previous day after unveiling new AI processors to compete with Nvidia, AMD shares experienced a strong bounce, jumping nearly 10% by the close. This positive momentum in chip stocks supported US futures, contributing to efforts to put a floor under the market. The semiconductor industry has been marked by intense competition and technological advancements, with companies like AMD making strategic moves to capture market share in the AI processor space. This sector's volatility and rapid developments often impact investor sentiment and market dynamics.

Forex markets

The recent move towards pricing non-recessionary "adjustment cuts" in the U.S. has contributed to Dollar weakness. This aligns with the expectation that Dollar strength will erode gradually and unevenly as pressure eases on other global jurisdictions facing economic challenges. However, a critical factor in the outlook for a stronger U.S. dollar is the confidence in the U.S.'s growth resilience compared to other regions. Recent data has shown faster disinflation in the Euro area, coupled with sluggish activity in France and Germany and potential fiscal restraint in Germany. The ECB will likely cut rates ahead of the Fed, responding to near-recessionary growth rather than mere "adjustment."This scenario doesn't bode well for Euro strength

In the case of the Japanese Yen (JPY), traders found themselves unprepared for adjustments in risk positioning, dismissive of signals hinting at changes in Bank of Japan (BoJ) policy. The situation took a turn when BoJ Governor Kazuo Ueda communicated with Prime Minister Fumio Kishida. Consequently, we observed a widespread shift into the Yen, driven by considerable dry powder among Japanese institutions waiting to be deployed. This development led to a significant market event in the past 24 hours, resulting in a noteworthy rally of 4 big-figure dollar handles for the JPY.

Oil markets

Oil prices experienced a stall near a 5-month low as investors adopted a cautious stance ahead of the U.S. employment report anticipated on Thursday. The report is expected to reveal modest job growth in November, reflecting a pullback in new hiring by employers amid a notable economic slowdown following robust growth in the third quarter.

The momentum in oil futures rode a modest downdraft on Thursday following the release of overnight trade data from China, revealing a decline in crude inflows. The data indicated that Chinese oil imports in November were at 10.33 million barrels per day (bpd), reflecting a decrease of over 1 million bpd from October's import rate of 11.53 million bpd. This figure is almost 9% below the import rate from when China grappled with COVID-19 lockdown measures a year ago.

In its November Oil Market Report, the Organization of the Petroleum Exporting Countries (OPEC) estimated that China's oil demand would increase to 16.29 million bpd during October-December, marking the most substantial quarterly consumption rate for 2023.

The latest data raises questions about the accuracy of this forecast, given the challenges faced by China's manufacturing sector in recent months and Beijing's struggles to provide substantial stimulus to its slowing economy.