The Market May Not Like What This Week’s Data Means For Rate Cuts

The first week of April will be busy, with plenty of data to come, mainly on the jobs front, with some peeks into the inflation prism. The ISM purchasing managers indexes, ADP Jobs report, JOLTS report, and employment report will tell us a great deal about the state of the economy and, more importantly, whether the “markets,” as in stocks, bonds, and the dollar, are playing it right.

When thinking about the market, it is essential to realize that it is more than just stocks because what bonds and the dollar have to say is far more critical than how stocks respond. This week’s data will be essential for bonds and the dollar, with stocks likely seeing knee-jerk reactions based on implied volatility levels and the fallout of bond and dollar movements.

ISM Manufacturing

Investors won’t have to wait long either, with the March ISM manufacturing report coming on Monday, April 1. Analysts see the headline index rising to 48.4 versus 47.8 last month; a reading below 50 suggests the manufacturing sector is still in contraction. Meanwhile, the prices paid index is expected to rise to 52.8 from 52.5, while new orders are forecast to rise to 49.8 from 49.2.

JOLTS

The February Job openings, or JOLTS, will be released on Tuesday. The number of job openings is expected to fall to 8.775 million, down from 8.863 million. The JOLTS data tends to be hard to predict and comes with substantial revisions. But more broadly, the data from the NFIB survey and the Indeed job opening data suggest that the number of job openings continue to decline slowly.

ADP

Wednesday brings us the ADP job report, with expectations for the number of jobs created in March at 150,000, up from 140,000 in February. The ADP data doesn’t correspond with the BLS employment data and should be considered a separate measure of employment. More recently, according to the number of jobs created in the government report versus the ADP report, the dispersion between the government report and the ADP report is growing wider.

ISM Services

The ISM services report also comes on Wednesday and is expected to rise to 52.8 versus last month’s 52.6. The number to pay the closest attention to is that ISM services prices paid, which last month was 58.6. The services prices paid index helped identify a trend in overall CPI inflation. It has even noted the big jump in services CPI for the January report and the lower values in February. While not as volatile, the trend in ISM service prices paid can help establish whether the trend in core services and supercore CPI is higher or if January and February were a one-off.

BLS Employment Report

Finally, the BLS employment report will be released on Friday, and it is expected to show that 200,000 jobs were created in March, down from 275,000 in February. Of course, revisions will play a key role in how this report will be received because revisions lower for February would dampen the impact of any beats on the headline. Meanwhile, unemployment is expected to fall to 3.8% from 3.9% last month. Average hourly earnings are rising by 0.3%, up from 0.1%, and 4.1% y/y, down from 4.3% last month.

While there have not been many cracks in the employment data, at least based on initial and continuing claims, the one concern comes from the NFIB small business hiring plans index, which has plunged in the last few months. The NFIB hiring plans index seems to do a decent job of getting the trends right over time, significantly when the index is adjusted to lead the BLS employment report by 2 to 3 months or so. This means the employment reports will need to be watched closely for any sign of slowing in the job; it could even be one reason why the Fed is treading so carefully at the moment.

Meanwhile, unemployment seems unlikely to change much based on continuing claims, which have been relatively consistent since July and August. So, it would seem reasonable to suggest that the unemployment rate doesn’t see any meaningful upward changes.

All in all, this seems to suggest that the employment picture is coming into better balance. The number of job openings is expected to decline at a modest pace, and there is not much to indicate that the unemployment rate should rise sharply, at least not in March.

Financial Conditions Will Be Forced To Tighten

If the economy stays healthy, it will give the Fed more reason not to cut rates. It becomes hard to imagine that the yield curve doesn’t steepen with the 10-year rising to the 2-year and the dollar strengthening, outside of a real shock to the unemployment data or an unexpected weakening in the ISM manufacturing and services, as long as the data comes in as expected.

At some point, the bond market and the dollar will have to respond to the rapid easing of financial conditions over the past several months and start tightening those conditions again. But with bond yields and the dollar index moving sideways since December and credit spreads collapsing, financial conditions have seen plenty of easing, which has essentially allowed the economy to reaccelerate and inflation rates to begin to pick up.

It seems clear that the market is now starting the process of removing rate cuts and is now looking for just two rate cuts in 2024 following the February PCE report, which could push the Fed Funds rate by December 2024 closer to 4.85%. This could drag the 10-year rate and the dollar index up, resulting in financial conditions tighten through the widening of credit spreads.

If the data for March is similar to that for January and February, it will become increasingly difficult for the bond market and the dollar not to respond. This would suggest that higher rates and a stronger dollar are likely coming, which would begin tightening financial conditions again. This will likely widen credit spreads and raise the stock market’s earnings yield. Credit spreads and stock prices have dislocated from the direction of bonds and the dollar since the beginning of the year, most likely because rates and the dollar have moved sideways.

While the market has been seemingly going in the opposite direction, with rates and the dollar diverging from credit spreads and equities, at some point, for this all to work, they will need to converge back on the same path if the data stays strong and inflation remains elevated. They will likely converge on a higher for longer path, which means higher rates, a stronger dollar, wider spreads, and lower equity valuations.

The analysts’ expectations would suggest a higher for longer path.