Asia open: Jolted by JOLTS

Markets

Stock market investors were sent reeling after US job openings unexpectedly rebounded in August, adding to concerns that the Federal Reserve could hike rates in November but unquestionably maintain elevated borrowing costs for an extended duration.

Jolted by JOLTS, Government bonds faced renewed selling pressure as the US jobs markets are still perceived as too strong, stocking inflation fears. On the back of the relentless rise in yields, the technology-heavy Nasdaq index headed for its most significant daily drop in two months, while the broader S&P 500 was not far behind on the interday race to the bottom. 

Stocks were meaningfully lower in the New York afternoon, and the proximate cause was another sharp selloff at the US long-end. It wasn't lovely, with yields higher by 10-15bps from the seven-year sector on out.

The benchmark 10-year Treasury yield increased by 0.12 percentage points to reach 4.80 % easily, a level not seen since August 2007. The longer-dated 30-year yield, also at its highest since 2007, rose by 0.14 percentage points to 4.93%.

A key factor underpinning the economy's strength this year has been a resilient US consumer who has benefited from a strong labour market. Fast forward to today, with the immaculate disinflation story getting a jolt from the past, the labour market's strength has intensified to the point where the soft landing expectations give way to an outlook for higher-for-longer rates in a cloudy and uncertain environment as robust data further fuels the "good news, is bad news" environment for stocks. 

The US stock market, which has a significant concentration of growth stocks and is sensitive to changes in interest rates, has largely disregarded persistently high real yields throughout this year. However, the current disparity between stock valuations and elevated real yields appears too substantial for stocks to ignore.

The correlation between real interest rates and equities has turned sharply negative again, and a significant gap must be closed. While there's no definitive rule that valuations and inflation-adjusted benchmark rates "must" reconnect, historically, there has been a strong link between equity multiples and real interest rates. The fact that the Dow Jones Industrial Average wiped out all its gains for 2023 on Tuesday highlights the precarious situation.

While it is difficult to see any change in the narrative until the US data rolls over, a few potential blustery headwinds may impact growth soon, including the end of the student loan moratorium, a potential payback in consumer spending after a solid summer, and higher oil prices, among others -- all of which could weigh on at least the willingness if not just the ability of the consumer to spend. 

While the recent tightening in financial conditions could make the Fed's job a bit easier, it's worth noting that the fading of recession and inflation risks has not necessarily translated into a tailwind for equities. 

Traditionally, bear steepening episodes in yield curves have been associated with a "risk-on" environment due to expectations of economic growth rebounding. However, the current bear steepening may be less supportive of risky assets, given the hawkish shift from the FED and increased supply dynamics playing a significant role in shaping market sentiment.

Equity risk premia, which are already low, could constrain equities' ability to absorb further interest rate increases. The relationship between equity beta (a measure of how a stock's returns relate to the overall market) and 10-year real interest rates is close to 20-year lows, excluding the exceptional conditions of 2020.

Furthermore, the enthusiasm driven by artificial intelligence (AI) that bolstered mega-cap stocks earlier in the year has moderated. Despite upward revisions in consensus expectations, mega-cap stocks have recently underperformed in the broader market. This suggests that market dynamics and investor sentiment devolved, so the previous enthusiasm for mega-cap tech stocks may not provide the same level of support in the face of "higher for longer" evolving market conditions.

Bonds are currently a significant challenge for equities. While bonds are oversold, the perception of an impending oversupply is acting as a psychological obstacle in the market, holding back traders from catching this falling knife.

The possibility of another government shutdown in November will likely lead the markets to expand their discussions on how higher interest expenses at the federal government level could impact the overall deficit. As interest rates rise, interest expenses for the federal government are expected to increase from 2% of GDP this year to 3% next year, resulting in more significant annual deficits. However, addressing this rise in the deficit through policy measures may be unlikely due to Congressional gridlock, a lack of political focus on deficit reduction, and the upcoming 2024 elections. These factors create an environment of uncertainty around fiscal policies and government finances, which will open up yet another can of worms.

Oil market

Oil traders have been on the Teeter Totter this week. Balancing the macro impact of higher rates against the backdrop of a tightly supplied oil market

The OPEC+ Joint Ministerial Monitoring Committee is scheduled to hold its monthly meeting on Wednesday to evaluate market fundamentals and recommend any necessary policy changes. Many analysts and traders anticipate that OPEC+ leaders Saudi Arabia and Russia will maintain their production targets previously extended for three months starting September 5, amounting to 1.3 million barrels per day (bpd) in output and export cuts. However, there is a possibility that Saudi officials might suggest extending the 1 million bpd production cut, initially implemented in July, into early 2024 to provide support for oil prices.

Recent sessions have seen oil futures facing selling pressure due to a combination of factors, including a stronger US dollar and increased production levels outside the OPEC+ coalition. These dynamics continue to impact the oil market and contribute to its volatility.