As we wait for payrolls, don’t expect risky assets to react in unison

Stock markets are tentatively recovering after the rout in tech stocks on Wednesday started to infiltate other markets. The driver of the sell-off was Wednesday’s hawkish Fed minutes, and a fear that markets bulls became too exuberant in their buying of risky assets earlier this week. As more people have come back to their desks post the Christmas break, there is a reassessment of what the surge in Treasury yields and the timing of the Fed rate hike later this year actually means for valuations of asset classes including stocks and FX. Interestingly, even as risky assets across the world wobbled on Wednesday and into Thursday, there was some differentiation, for example, commodity markets did not turn lower after the Fed’s minutes. On Thursday, at the time of writing, a barrel of WTI and Brent crude oil were both more than 3%, higher. 

The Fed’s latest hawkish twist 

The Fed minutes took the market by surprise, as it revealed that members of the FOMC are already talking about the timing of shrinking the Fed’s massive balance sheet, which would be yet another aggressive move to try and bring its Covid-era policy support to an end. It also comes hot on the heels of the Fed’s tapering announcement and also at a delicate time when the market is trying to figure out when the first rate hike will come from the US central bank. Right now, according to the CME Fedwatch tool, there is a 67% chance of a rate hike to 0.25%-0.50% at the March meeting, there was a 57% chance earlier this week. Thus, the market is pricing in a more hawkish Fed and the stock market is reacting. Unsurprisingly, the sectors that performed the worst in the S&P 500 on Wednesday were technology, real estate and consumer discretionary. These are all sectors that are closely linked to changes in interest rates and tend to perform badly when interest rates rise. As things stand, profit-negative tech stocks are likely to remain in the firing line for some time, especially if we get a strong payrolls report this week. 

Why oil is rising 

The surge in the oil price was fairly surprising to us especially after the Opec+ meeting confirmed that the oil cartel intends to stick to its plan to boost oil production in February. Added to this, US gasoline inventories surged to 10 million barrels as people hunkered down due to rising omicron infections in the US. The oil price rise is not totally going against the information tide, however. There is some concern that Opec + members including Nigeria, that produces some of the world’s best quality crude oil, will not be able to ramp up production for next month. Added to this, now that omicron is considered a fairly mild variant, the oil market is expecting a pick-up in demand as people get out of isolation and start to make trips again later this month. Thus, we could see some further upside for the oil price in the coming days, with $84 per barrel for Brent crude now in view, the high from the first week of November. 

Apple remains king in the tech sector, even if it is selling off 

Added to this, while tech stocks are slumping there is still some differential within the sector. For example, Apple fell 2.6% on Wednesday, while Tesla continues its slump after Monday’s 13% rally. We expect tech to remain under pressure as we lead up to Friday’s payrolls report, however, we still expect Apple outperformance in the tech sector. Even at these extremely high valuations Apple is still a great company in our eyes. It had record profits in 2021, and while it may struggle to top those numbers in 2022, it remains cash generative. Thus, if you like relative value trades, we prefer Apple over Tesla in Q1. 

Why US banking shares will recover after Wednesday’s dip  

Elsewhere, although interest rates in the US are poised to go higher, perhaps as early as this quarter, the banking index was not left unscathed from the S&P 500 sell off earlier this week, and it fell more than 1%. Interestingly, Citi Group was down 1.1%, whereas JP Morgan fell more than 2%. We think that the JPM had a steeper fall because of its sheer size, thus it is more exposed if the Fed presses on the brakes too hard and triggers a US economic recession. In contrast, Citi is more attractive to traders right now because it underperformed the US banking sector for most of 2021 and is looking better value than some of its counterparts. If we see a strong payrolls report on Friday, as we expect, then this could be the sweet spot for banking shares. Unsurprisingly, we are seeing US banking shares getting picked up on the dips as trading gets under way in the US on Thursday, and we expect this to continue as we lead up to the payrolls report. 

Prepping for Payrolls

The FX market is also on our radar as we lead up to Friday’s payrolls report. While US jobless claims edged up to 207,000 last week, there are still no signs that Omicron is causing mass layoffs. The ADP employment report for December was released on Wednesday and it reported that private sector employment growth was a whopping 807k in December, far exceeding the 400k expected. While the ADP report is not particularly correlated with the NFP report, it still suggests that the US labour market is strong, and this supports hawkish action from the Fed. Wage growth is also worth watching out for, the annual rate is expected to moderate slightly to 4.1% from 4.8% in November. However, this makes it even more pressing for the Fed to tackle inflation as real wage growth (when adjusted for inflation) is negative, which also hurts the consumer. Thus, a pause in wage growth in the US for last month is bad news for the consumer discretionary sector, as it means less leftover income to spend on the nice-to-haves consumer discretionary items.  

The dollar outlook

The payrolls report is important for the dollar, if we get a strong rapport then the dollar may resume its dominance after falling vs the EUR, GBP and JPY on Thursday. This was another anomaly to the overall market reaction to the Fed minutes on Wednesday, when the Fed is hawkish you expect the dollar to be strong. However, the dollar index fell back to the 96.00 level. If the selling pressure on the dollar gains conviction, then the Dec 31 low at 95.57 should act as short-term support, however, we think that any dip to the 95.00 support zone will be met with buying pressure. The long-term picture remains for a stronger dollar, as long as the dollar index remains above its 200-day sma at 93.04.