Mechanical aspects of the market took over on Friday after the surprise job report. The job growth was nearly double what was expected, while unemployment and wage growth were basically within the same range they had been for months.
So, if there is progress in the labor market softening, it is tough to find, and the pace at which wage growth is coming down is way too slow to meet the Fed’s 2% inflation target anytime soon. The Fed needs wage growth closer to 3%, which is still over 4%. And while this job data alone isn’t likely enough to raise rates in November, it just pushes out the timeline for rates to stay higher.
The changes in the path of monetary policy will not be found when looking for future rate hikes but will be found when the market is looking for rate cuts, and that changed on Friday. The call before the job report saw the first full rate cut coming in June, and that is now seen coming in July.
The results of the job report sent rates soaring and could have provided a preview of what is to come in the weeks ahead, with the ten and 30-year rates surging to almost 4.9% and 5.05%, respectively. It was the initial surge in rates that sent equity futures plunging, and it was the profit-taking in rates that followed that helped push stock prices higher, coupled with an implied volatility crush too.
10-Year Futures Contract
The price of the 10-year futures contract after the data release traded sharply lower, and the S&P 500 Futures traded down as 10-year rates surged. As treasury prices rebounded, probably as profit taking took place from those short futures, it helped to lift the equity market along with it because, if anything, it seems that the equity market is more positively correlated to the bond market over the past 2-years more than any recent time in memory.
Short positioning in the 10-year is near record levels, and long positions in the 10-year are very low. So clearly, the market is heavily net short the 10-year and other bond contracts, and it seems possible that profit-taking in the morning drove rates off their highs and pushed bond prices up.
But we can also see that as the day went on, the gap between stock and bond prices separated, and the separation was likely due to the implied volatility crush that we see after a typical event, as event risk ebbs.
The S&P 500 followed along with bond prices until 12:30 PM ET, when the VIX crush started, pushing stock prices higher. So the rally in the equity market had more to do with short-covering and profit-taking, volatility crushes, and mechanics than it had to do with some view that we are on a “golden path” to an “immaculate soft-landing.” Maybe we are on a path to a soft landing, but the more resilient the economy, the longer rates will stay higher, and the greater the risk that rates will go higher.
The risk here is that rates do go higher because the spread between the 10-year futures rate and the 10-year nominal rate is collapsing and appears to be heading back to levels in past decades, which is part of an arbitrage; it would seem what is probably part of a short-basis trade. It would make you think that as long as there is a spread to close, nominal rates on the 10-year probably move higher.
S&P 500 Rallied
Meanwhile, the S&P 500 rallied to a resistance region of around 4,320 on Friday. It stopped, which was part of the August 2022 highs, which is essential because that area has acted as support and resistance.
Unless the S&P 500 gaps over the 4,320 level on Monday, I think the 4,320 level holds, and the index trades lower and gives back much of the gains we saw on Friday, which probably means we get another retest of 4,200 at some point this week. If, for some reason, we do gap higher, there is still that gap at 4,400 that hangs out and is likely to be the next central resistance zone for the index.
NASDAQ (NDX)
For the Nasdaq 100 it managed to rally, too, but it hit right up against resistance on Friday at the January uptrend and stopped. The NDX has occasionally tested that trendline and can’t get through it.
Again, the NDX must gap over that trend line on Monday morning. Otherwise, we see the index back down and test the 14,270 area. It seems plausible if we do a gap higher than a rally to around 15,250.
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