Tomorrow is the big one – the August employment report. Last week, Nvidia (NVDA) was understandably the biggie, even if its good but not great results, failed to cause broader repercussions. But it is nearly impossible to assert that non-consensus August Nonfarm Payrolls and/or Unemployment would fail to move stock and bond markets. The upcoming FOMC meeting potentially hinges upon those numbers. A Goldilocks scenario around consensus – not too hot, not too cold – is what equity bulls require.
Hyperbole? Perhaps. However, the recent Jackson Hole address by Federal Reserve Chair Powell (aka “Goldilocks in a Suit”) seemed to all but promise a rate cut at the September 18th meeting, and more importantly, reaffirmed that after years of seeming to solely focus upon the “stable prices” portion of the Federal Reserve’s dual mandate, the “maximum employment” goal is now in play after a few months of weaker labor data. Thus, with a minimum of 25 basis points a near-certainty, the labor report is viewed as the most important factor toward a potential 50 bp cut.
Considering the markets’ mood, the reports need to thread a fairly narrow window around consensus, which is currently around 165,000 for Nonfarm Payrolls and a 4.2% Unemployment Rate. I’ll refrain from making my own predictions – that’s a job for economists, not strategists — but if you have a specific view on either of these numbers you should consider utilizing the IBKR ForecastTrader. It currently shows a 65% likelihood that August payrolls will exceed 147,500 which broadly fits with the current consensus. (Remember, consensus expectations can move after a contract is listed).
The key for most investors and traders is not to figure out what the number will be, but instead, how the markets might react to various scenarios. Considering that fixed income traders seem roughly split between expecting 25 and 50 bp at the next meeting, and that a substantially weaker number would pump up the chances of 50bp, while a significantly stronger one would dash hopes for a larger cut, a number that widely deviates from consensus would mean that a large percentage of investors would be caught offsides. And when traders are caught offsides, volatility ensues. (Note: as of midday, the CME FedWatch tool shows a 39% likelihood for a 50bp cut in September, while ForecastTrader shows 81% likelihood for a Fed Funds rate set above 4.875%),
After a failed rally attempt this morning, fueled by another bout of “buy-the-dip” in megacap tech stocks, we see risk-averse sentiment return to equity markets. The Cboe Volatility Index (VIX) briefly dipped below 20 this morning but has now returned to a 21 handle. At-money options the for S&P 500 Index (SPX) that expire tomorrow are pricing in a roughly 1.65% move, though we see a very steep downside skew below 5,350:
Skews for SPX Options Expiring September 6th (magenta), September 20th (pink), October 17th (yellow)
Source: Interactive Brokers
Meanwhile, as we might intuit from the large flattish area in the top curve above, the IBKR Probability Lab shows a wide dispersion among the most likely outcomes, even if the peak probability remains about 1% above the current index level:
IBKR Probability Lab for SPX Options Expiring September 6th, 2024
Source: Interactive Brokers
Here’s the bottom line. Since rate cuts have become a near-certainty we’ve entered a “bad news is bad” environment. The danger in really bad news is that even if the Fed is prepared to react aggressively, it might be too late to stave off real economic weakness. But there is a worry that if the news is too good, that the Fed might be reticent to cut rates as fast as the market has come to expect. A data-dependent Fed is not likely to offer the four 25bp cuts that the markets expect to arrive during the remaining three FOMC meetings this year. Thus, a “Goldilocks” payrolls report – not too hot, not too cold – is what equity bulls should desire.
Disclosure: Interactive Brokers
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Disclosure: Options (with multiple legs)
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