Bad News is Good
October 5, 2023
The focus remains on the recent backup in bond yields with markets in waiting mode ahead of tomorrow’s Jobs Report. Weekly jobless claims fail to confirm the softening labor market message in yesterday’s ADP report with a below-consensus print of 207,000. Markets are in a ‘bad news is good’ phase with the improvement in claims weighing on equities.
The S&P 500 (SPX) is oversold and holding above the bullish inflection and 200-day moving average near 4200. The probability of a relief rally from current levels would be high in a benign rate environment, but the recent spike in the MOVE Index increases the likelihood of aftershocks. The MOVE Index measures bond market volatility, which tends to spill into equity market volatility as measured by the VIX Index. The VIX Index currently sits at 19, which is very close to levels that act as a headwind for relief rallies. A break below 4200 would turn the outlook outright bearish and likely result in the VIX reaching escape velocity north of 22.
In our opinion, bond prices are currently dislocated from their longer-term fundamental drivers that include terminal Fed rate expectations, growth and inflation expectations. Ten-year yields look ~40bp too high using fundamental drivers only. Non-fundamental drivers of the recent backup in yields include position hedging in futures markets, increased Treasury issuance and expectations for rising fiscal deficits. Positioning indicators are now pretty close to neutral, while concerns over increased Treasury issuance will likely fade when fiscal deficits are addressed.
Tomorrow’s Jobs Report and next Thursday’s CPI print could materially change the outlook for bond yields and equities. Markets are in a ‘bad news is good’ phase with an inline or weaker-than-expected non-farm payroll number resulting in lower bond yields and a relief rally for the SPX. Consensus is looking for +163,000 job additions with numbers above ~225,000 resulting in higher yields, increased volatility and the SPX likely break below 4200.