Get out the popcorn as NFP enters the purview

Markets

Get out the popcorn, it could be an entertaining 48 hours as traders jockey for position into and eventually out of the granddaddy of all economic releases, US Non-Farm Payrolls.

U.S. equities closed well off interday highs even as Treasury yields continued to decline. While surprising to some, it's intuitive to others who are sounding the "careful what you wish for" alarm on the back of a softer tier 2 employment data ahead of Friday's Non-Farm Payrolls (NFP) reading. Without stating the obvious, the U.S. labour market is showing signs of contracting much faster than expected. This is not necessarily a "risk-on" panacea, especially if the downward momentum in the jobs markets picks up a good head of steam.

While ADP's historical accuracy as a predictor of NFP has been weak post-pandemic*, most traders (Carbo-based) (unlike news reading algorithms) do not place much weight on the ADP miss. Still, on the surface, Wednesday's data can be seen as another piece of the labour market rebalancing puzzle and underscores the dovish message conveyed by Tuesday's JOLTS release. 

But investors are likely cautiously awaiting the more comprehensive labour market data from the NFP report scheduled for release on Friday before making any tactical year-end moves.

 While the government's jobs report is anticipated to be a decisive factor, the bar for the report to send an unequivocally strong or hawkish message has now been set relatively high. Indeed, the softer read on job openings (JOLTS) might make it more challenging for the NFP to confirm a coherent picture of a hotter labour market than expected. Still, a big number can move the policy needle for no other reason than the 125 bp + of rate cuts that were quickly priced along the curve in the wake of Fed Waller's recent dovish comments, which more or less greenlighted the wave of rate cut bets.

After last month's tectonic shift in bond market sentiment and the ensuing meteoric rally in stocks, the follow-through flow dynamics so far this month are showing obvious signs of exhaustion for the lack of a better colloquialism.  

While the growth outlook has moderated in recent weeks from the 5%+ pace we saw in 3Q23, the economy does not appear to be heading for a recession in 2024, which -- despite progress on inflation -- might not compel the Fed to cut as aggressively as the current market pricing might suggest. Couple this with concerns that investor optimism is reaching a potentially precarious level thanks to the +125 bp of rate cuts priced into the curve, and you have a recipe for a sell-off in the making on any hawkish Fed pushback or stronger message in the economic data bottle.

Putting aside concerns of overstretched technical indicators( If you look hard enough, you can always find a tech level to justify a bad trade), the growing belief that the Federal Reserve may not cut interest rates as swiftly as currently anticipated by the markets is likely the biggest worry for stock market investors at the moment.

Oil markets

The decline in oil prices to a 5-month low is attributed to a supply overhang and concerns about softening demand. 

The recent sell-off intensified during the New York afternoon session following the release of inventory data from the U.S. Energy Information Administration (EIA). The data indicated a substantial increase of 8 million barrels in total refined product stockpiles last week.

Still, the critical factor in this week's sell-off is attributed to Saudi Arabia's announcement of a reduction in official selling prices for its flagship Arab Light crude in January.

 This decision to cut prices across key markets reflects weak demand fundamentals globally. Saudi Aramco implemented a price cut of $0.50 per barrel for Arab Light crude for January loadings to Asia, bringing it to $3.50 per barrel over the Platts Dubai/Oman average. 

Similar reductions were made for other regions, including Northwest Europe and the U.S. Gulf Coast, highlighting the broader impact of diminished demand on oil prices.

What is driving this "everthing rally"?

A significant portion of last week's discussions focused on the flow drivers behind the historic market movements in November. Notably, CTAs (Commodity Trading Advisors) and vol control strategies were highlighted as playing prominent roles in the market dynamics. In the managed futures space, there was a reflection of the broader macro-policy reversal, with existing positions in hawkish rate bets and bond shorts experiencing a substantial "one-way buy-to-cover" trend. Additionally, a notable reduction in realized equity volatility triggered mechanical buying of stocks from the vol control universe. The combination of these factors contributed to the exceptional market movements witnessed in November.

According to Goldman's Scott Rubner (whom Bloomberg amusingly described this week as a "tactical specialist"), those dynamics may be largely exhausted. 

"The flow-of-funds dynamics that caused the everything rally in November have absolutely run out of gas right now," Rubner wrote, describing $225 billion in CTA buying over the last month as "the fastest increase in exposure that we have ever seen."