Jobs blowout meets Oil shock: Bonds sell off as Fed remains between a rock and hard place

Good morning…I’m back – and let’s see what I missed…

Well, OK then — apparently nobody told the labor market that it was supposed to be slowing down.

Because while traders were packing up and heading OUT to the beach for one final long weekend of summer, the August jobs report showed that we created 162k new jobs…. nearly 3 x’s the expectation… Unemployment held steady at 4.1%, labor-force participation ticked up to 61.6%, average hourly earnings rose 0.3% m/m and 3.1% y/y, while the average workweek ticked up to 34.4 hours.

And then there were the revisions.

June was revised UP by 11,000 jobs, July was revised UP by 44,000 jobs, turning what had been reported as a LOSS of 23,000 jobs into a GAIN of 21,000 jobs.

So, June and July together were 55,000 jobs stronger than originally reported. And just like that — the conversation changed and that gave the bond market another reason to throw a fit while the FED found itself stuck between a rock and a hard place.

Recall, the debate was whether the economy was slowing enough to allow the Fed to sit tight, whether inflation remained the bigger problem and whether Hammack and Schmid were right to keep warning investors that rates may need to go higher.

Well — Friday’s jobs report gave the hawks another piece of ammunition because 162k new jobs, positive revisions and unemployment holding at 4.1% hardly suggests that this economy is in trouble and needs the Fed to come riding to the rescue.

And you know where I’ve been on this. I remain in the camp that the Fed does NOTHING in September – although the market is pricing in a 58% chance of a hike….and I still think there is a very real possibility that they do nothing for the rest of the year. I think Kevy is going to let the bond market do the heavy lifting for now rather than have the Fed hike rates by 25 bps - especially when the bond market has already tightened financial conditions for him - 10 yr yields are up 22% since the March 1^st low.

And remember - the 10-yr is the benchmark for the cost of long-term money. Mortgages, corporate borrowing and a whole range of other financing costs take their cue from this metric. So, if the bond market is already raising the cost of money and slowing things down – does Kevy really need to pile on?

On Friday bond vigilantes continued to put the pressure on - they sent prices lower – and yields higher…. the 2-yr shot up to a high of 4.41% before settling at 4.36%. The 10-yr shot to a high of 4.81% before settling at 4.78% while the 30-yr traded up to 5.27% before ending at 5.24%. This morning – yields are up again…the 2 yr is yielding 4.37%, the 10 yr is yielding 4.81% while the 30 yr is yielding 5.266%.

Now, stocks didn’t love all this news, and at the end of the day – the Dow lost 272 pts, the S&P lost 30 pts, the Nasdaq gave up 78 pts, while the Russell added 7, the Transports added 150 pts, the Equal Weight lost 45 pts while the Mag 7 ended the day flat.

And THAT is important - because if investors really believed Friday’s jobs report was some kind of disaster, stocks would have gotten punched in the face. They didn’t. The S&P lost less than half of one percent, so the message wasn’t really coming from stocks. It was coming from bonds.

Now, move onto oil because that ended higher as well, but not because demand is out of control, because the mid-east is still on fire and the flow of oil remains disrupted. WTI was up 10% on the week, while Brent was up 7.6% for the week.

Now while we were all taking the weekend off – the tensions in the middle east did not.

This morning – oil is higher again – because while we were all enjoying the last weekend of summer - U.S. forces struck three Iranian oil tankers on Saturday — including one near Kharg Island, Iran’s key oil-export hub. Iran retaliated, threatened U.S. energy interests across the Gulf and warned that they intend to further restrict shipping through the Strait of Hormuz.

And then overnight — Iran-backed Houthi rebels attacked Saudi Arabia, hitting energy facilities in the southern part of the kingdom and forcing some operations to temporarily shut down.

So, again, this isn’t about booming U.S. demand. This is about SUPPLY.

And that puts Kevy in a very difficult spot. Because raising rates isn’t going to FIX the oil problem. The Fed can’t produce another barrel of oil, repair a Saudi facility, reopen the Strait of Hormuz or solve Iran.

But here’s what the Fed CAN do. It can raise rates enough to slow the economy and attempt to DESTROY demand for oil - and if you destroy enough demand, eventually you can put downward pressure on the price.

But think about what that means. How much economic pain do you have to create to destroy enough demand to offset a geopolitical supply shock? That’s the dilemma. Kevy can’t fix the SUPPLY side of the equation. He can only attack the DEMAND side - and that comes with a price.

And THAT is why I continue to think the Fed sits tight in September. Especially when the bond market has already done most of the work for him.

And this morning? Brent is kissing $100/barrel. WTI is trading above $94. Bonds are being sold and that is sending yields up. This morning - the 2 yr is yielding 4.37%, the 10 yr is yielding 4.81% while the 30 yr is yielding 5.266%. And by the way - today we kick off another heavy round of Treasury issuance with a $58 billion 3-yr note auction, followed by 10-yr and 30-yr offerings later this week.

So, the bond market is about to get tested AGAIN.

Gold got slammed - falling 1.2% to end Friday around $4,419/oz because bond yields surged and the dollar rallied by 0.25% to end the day at $99.15.

Remember - higher rates and a stronger dollar increase the opportunity cost of owning an asset that doesn’t pay you anything. No dividend. No interest. So, the markets do what they do – they price risk. And as yields rise, interest-bearing assets (bonds) become more attractive relative to gold – so gold gets sold.

Here is how you think of it -

Jobs beat + rising rate hike expectations + higher yields + stronger dollar = gold gets sold. It is not any more complicated than that.

And global stock markets are under pressure.

Asian stocks lost ground – Japan – 1.7%, Australia down 1%, South Korea and Taiwan down 0.5%. We are also expecting a monetary policy announcement from the BoJ next week.

Stocks in Europe are lower as well – but not panicky…markets across the zone are down between 0.2% - 0.45%. The ECB announces their rate decision on Thursday, and the BoE announces their decision next week. Both are expected to raise rates.

U.S. futures are pointing to a weaker opening as investors & traders return from the holiday weekend. Dow futures are down 390 pts, S&P’s down 20, Nasdaq down 10 while the Russell is down 10.

Key economic indicators this week – PPI on Thursday, which is expected to show some additional inflation pressure, and then CPI on Friday – where the expectations are a bit more mixed. And after the strong jobs report and oil kissing $95 – you can bet that everyone will be watching.

Both of these reports are just days ahead of the FOMC meeting next week that begins on Tuesday with the rate announcement and Kevy’s press conference on Wednesday.

Which means we are now officially in the Fed’s blackout period – which means no more speeches, interviews or public commentary from FOMC officials about monetary policy ahead of the meeting.

And recall – under prior Fed chairs, whenever the Fed appeared to be leaning toward something that the market wasn’t expecting, traders would immediately start looking for clues from Goldman Sachs or the WSJ’s Nicky T. I refer to them as the Fed’s “deep throats” because somehow they would always have the inside scoop in the event of a change in psychology ahead of everyone else.

Now – whether Kevy plays the game the same way remains to be seen. But with the Fed officially quiet, PPI on Thursday and CPI on Friday – the data gets to do the talking – exactly what Kevy wants.

Remember – September is historically one of the most difficult months of the year for stocks. Since 1950, the S&P has averaged a loss of about 0.7% and has finished the month higher just 44% of the time. And when September DOES finish lower, the average loss has been closer to 4%. So, with bonds under pressure, oil kissing $95, the Fed in play and geopolitical tensions rising – my gut says this is not the time to be complacent.

Mahogany Chicken

Prep time

20m

Cook time

45m

Total time

1h 5m

Serves

4-6

Ingredients

6-8

Thighs & Breasts on the Bone

Olive oil

10

Garlic cloves

fresh rosemay, sage & thyme

1 large

Onion

1 can

black olives

s&p

thick Balsamic Vinegar - nice quality

Preparation

Step 1

Soak & clean the chicken.  Pat dry on paper towels.  Arrange in a roasting pan.  Drizzle with olive oil, rub it onto each piece. Season with s&p.

Step 2

Peel garlic and arrange around and under the chicken parts.  Add rosemary, thyme, sage & bay leaves. Put the herbs around and under the larger pieces of chicken. 

Step 3

Add 2 cut up large onions and spread it around the chicken.  Use Vidalia onions if you have them, but any onion will work.

Step 4

Roast the chicken in the middle of a 400-degree oven for about 45 minutes.  Check the pan every 15 minutes or so and remove any excess liquid with a turkey baster.  The object is for the chicken to roast, not braise. - Save the juice on the side in case someone wants some with their meal.

Step 5

After 45 minutes, drizzle the chicken with the balsamic vinegar, add the olives, turn the heat up to 450 degrees, and roast for 15 minutes more.

Step 6

You can serve this with roasted vegetables, roasted potatoes or rice.  Always include a tossed green salad.