(USTs lower on 'about average' volumes)while WE slept; "Trading Tomorrow" (always) and "The Market's Next Big Pain Trade" (in bonds...ahead of NFP...read)

Good morning.

Overnight we heard from the Grinch, once again (as we heard similar rumblings out of the BoJ this time last year, too, if not mistaken). BOJ Ueda said they have several options on which interest rates to target when they end negative rates.

Reuters: BOJ chief meets premier Kishida, explains focus on wages, demand

Summary

• Explained need to check wage, demand, service prices - Ueda

• Meeting with PM held amid market expectation of near-term exit

• BOJ to face 'even more challenging' situation - Ueda

• Various options on which rate to use as policy target - Ueda

It would appear that 10yr JGBs reacted TO this and appear to have popped (but that is assuming they traded over night AND without a BBG, it’s also assuming these prices via TradingView are reflection of truth)

Fitting (but not the same level / degree) ‘bad news’ from Japan on this, THE anniversary … “December 7^th 1941 – a date which will live in infamy – the United States of America was suddenly and deliberately attacked by the naval and air forces of the Empire of Japan”.

(actual picture of what many assumed would happen to the UST market with this sort of headlines … still waiting…)

Moving along and thinking about a BIG question here … will this weeks JOLTS combine with ADP (HERE is link from ‘the horses mouth) AND some ‘spin’ …

CalculatedRISK: ADP: Private Employment Increased 103,000 in November
ZH: Hospitality Jobs Tumble For First Time In Almost 3 Years As ADP Disappoints

… be the usual massive head fake / prelude to a larger than life NFP (think last time ADP was this weak, NFP was actually quite robust)?

Will this mornings Initial Jobless Claims weigh in?

SO many questions so little time and so … here is a snapshot OF USTs as of 705a:

… HERE is what this shop says be behind the price action overnight…

… WHILE YOU SLEPT
Treasuries are lower with the belly underperforming (2s5s10s +1.9bp) ahead of NFP and next week's truncated auction schedule- with bond prices locally 'overbought' too. The JGB market was also pounded overnight with 5yr JGB yields (+10.5bp) seeing the biggest single-day increase since 2013 according to Reuters. A poorly attended 30-year JGB auction seemed to be the spark. DXY is lower (-0.25%) while front WTI futures are higher (+0.75%). Asian stocks were generally lower, EU and UK share markets are a hair lower on balance while ES futures are ~UNCHD here at 6:45am. Our overnight US rates flows saw a wild Asian session with volumes building into the afternoon as JGB's cratered with real$ selling intermediates out to the long-end in the Tsy market. Swaps were also very active with paying in 5s10s30s and 5y5y outright alongside paying US 5y5y to receive Aussie 5y5y. During London's AM hours, prices recovered around 70% of Asian losses though we saw better selling in the 5yr-7yr sector from real$. Overnight Treasury volume was about average overall despite 2x normal volumes during Asian hours...

… Our first attachment looks at the set-up in the daily chart of Treasury 10yrs. 10yr yields are currently back near September's closing lows and not far from July's high yield print. Moreover, in the lower panel you can see how deeply 'overbought' shorter-term momentum is- which is a typical condition in the early stages of major bull trend reversals. The 4.50% level is your key support above and 10's sit at resistance with the employment data/auction combo looming. Again, a tricky time/place with medium and long-term momentum studies so clearly bullish now, as your backdrop.

… and for some MORE of the news you can use » The Morning Hark - 7 Dec 2023 and IGMs Press Picks (who CONTINUES to be sportin’ that new, fresh look) in effort to to help weed thru the noise (some of which can be found over here at Finviz).

Moving from some of the news to some of THE VIEWS you might be able to use… here’s SOME of what Global Wall St is sayin’ …

Barclays: China: A big miss in imports points to weaker Q4 domestic demand

China's imports missed market expectation by a wide margin. We think the contraction in imports (led by oil and base metals) confirmed softer domestic demand in Q4. The improvement in y/y exports was largely due to favourable base effects, and we expect headwinds from external demand to linger. 

Bespoke: Trading Tomorrow (buy and hold OR just always FADE DOWN DAYS…)

Here's a pretty remarkable stat for you...

Using the S&P 500 tracking ETF (SPY) as a proxy for the US stock market dating back to the ETF's inception in 1993, we wanted to see how an investor would have done if they only owned the market on the day after "up days" versus only owning the market on the day after "down days."  The hypothetical strategy is pretty simple to calculate (and also not replicable without factoring in trading costs).  As shown below, over the last 30 years, had you only owned SPY on trading days that immediately followed down days for SPY (days where the ETF closed in the red), you'd be up 785%.  Conversely, had you done the opposite and only owned SPY on trading days that immediately followed up days for SPY (days where the ETF closed in the green), you'd be up a measly 16.7%.

An emotional investor typically feels good after market up days and crappy after market down days, but basically all of the stock market's price gains over the last 30 years have come from the trading days that followed down days.  This makes sense given that the market has risen dramatically over time and is essentially at its all-time highs on a relative basis, but it's still a quite stunning performance stat to think about.

The moral of the story?  Buy and hold obviously works best, but also: don't let down days get you too down! …

BNP: OPEC+: Paper cuts? (see below for comic version)

• We believe the OPEC+ November cuts will amount to about 400,000 barrels a day of incremental reduction.

• While much less than pledged on paper, it is higher than what is currently reflected in prices, in our view.

• We believe these cuts will remove most stock builds in Q1 2024, keep Dubai crude expensive versus Brent, and amplify the problems of EU refiners having to run heavier crudes, supporting ICE gasoil prices.

DB: US Strategy Update - 2024 US rates outlook: A steeper path to normal (so … not a new normal, that was taken like a decade ago)

• We expect a mild recession with inflation on-track to 2% to lead the Fed to cut more aggressively next year than market pricing or Fed projections; our forecast has the fed funds rate moderately below neutral in 2025.

• As cuts come into view, we expect yields to decline and the curve to steepen, but with long-end yields supported by an above-consensus neutral policy rate and structurally higher term premia. Our forecast has 2y and the 10y UST yields ending next year at 3.15% and 4.05%, respectively.

• Under our baseline of mild recession and Fed cuts to actively ease the policy stance, QT will be phased out. In a soft-landing, QT will continue alongside rate cuts, likely extending into 2025. The Fed is keen to reduce the balance sheet, which raises the likelihood that QT continues.

• In money markets, funding stress risk has risen but we still see it as subdued by historical standards. We expect the ON RRP to fully drain around the middle of next year, making banks the marginal lender of cash. Rising repo rates will likely activate SRF usage. We also expect the Fed to make a technical adjustment that lowers the RRP rate by mid-year.

• Expectations of heavy issuance and duration supply are already embedded in market pricing, but as supply is absorbed by the market it should keep upward pressure on term premia. We see demand as more balanced next year, with most groups of investors buying the same amount of or more Treasuries.

• We are negative on front-end and intermediate swap spreads due to liquidity and funding, and moderately constructive on long-end spreads on pension demand and Treasury buybacks. We retain a steeper spread curve view.

• Near-term risks to front-end CPI pricing are tilted to the downside, while 5y5y breakevens are low relative to long-run inflation expectations and uncertainty. We favor higher inflation risk premia and a steeper breakeven curve.

• We expect key policy developments in Q1, with the Fed allowing the Bank Term Funding Program (BTFP) to expire without extension and the Treasury announcing the start of buyback operations at the February refunding.

DB: Mean (trend inflation) less mean to Fed (trend of disinflation continues BUT…)

• Both headline and core PCE 12-month inflation continued to fall in October, the former by 42bps to 3.0% and the latter by 19bps to 3.46%. Updating our suite of statistical models, we find that our monthly mean estimate for trend inflation declined by about 7bps to 3.1%, while the median estimate rose 12bps to 3.6%, reflecting the recent pickup in inflation expectations from the University of Michigan survey. To be sure, both metrics remain at historically elevated levels.

• Our updated dashboard shows that progress on reducing trend inflation is continuing. However, the skew in the distribution of our various trend estimates suggests that the degree of progress is varied, and, as such, the Fed is likely to keep a soft tightening bias at the December FOMC meeting (See Powell cautions market to handle rate cuts with care). While many Fed officials, including Chair Powell, noted that speculation about rate cuts is premature at this moment, the discussion around a normalization of monetary policy will turn more active next year as progress on inflation continues further. In terms of rate cuts, we maintain our view for the first rate cut in June and 175bps of total cuts next year as the economy slips into a mild recession in Q1. That said, an earlier cut could happen if there is more uncertainty around the prospects of a soft landing coupled with better-than-expected progress on inflation (See How soon is too soon for soft-landing rate cuts?).

Goldilocks: ADP Employment Below Expectations in November; Productivity Growth Revised Up in Q3; Trade Deficit Widens (NFP guess UNCH for now)

BOTTOM LINE: According to the ADP report, private sector employment rose by 103k in November, 24k below consensus expectations and led by an increase in services employment. We do not place much weight on the ADP miss because of ADP’s negative correlation with BLS private payrolls since the introduction of the new methodology. We left our nonfarm payroll forecast unchanged at +238k ahead of Friday’s release. Nonfarm productivity was revised up by 0.5pp to +5.2% in the third quarter (qoq ar), above expectations, and unit labor costs were revised down by 0.4pp to -1.2%, below expectations. The trade deficit widened in October from a downwardly-revised level. The trade details were similar to our previous assumptions, and we left our Q4 GDP tracking estimate unchanged at +1.5% (qoq ar). Our Q4 domestic final sales estimate stands at +2.1% (qoq ar).

HSBC: Fixed Income Asset Allocation Fixed Income (back to BULL)

2024: Dragon claws Global

◆ We expect the Year of the Dragon will bring bond investors a continued clawback from previous losses
◆ US inflation has been on a falling trend for 18 months, and real yields are significantly higher than one year ago…
◆ …well above where we see longer-run equilibrium, and representing a more-than-sufficient risk premium

US Treasuries – bullish
We are prepared to be patient and remain bullish US Treasuries, leaving our end 2024 forecast for the 10-year at 3.0%. The strong performance of November means that returns for the year are back into positive territory. It also means that initial conditions going into the new year are not as attractive as they were, and we are wary that the last few years have given us several false starts. This said, the disinflation trend has continued, both in the US and abroad, allowing the focus to shift to signs of a slowing real economy…

MS: Employment Report Preview (NFP PREcaps and to be followed by victory laps)

We estimate payrolls rose 200k in November, but excluding strike effects rose 165k. The unemployment rate is unchanged at 3.9% amid further labor force gains. Average hourly earnings rise 0.3%, and the 12-month pace slows further to 4.0% from 4.1% in October and 4.3% in September.

UBS: ADP posts another modest gain (“ADP have not been correlated with BLS data year-to-date”)

ADP estimates private employment rose 103K in November
ADP estimates private employment moved up 103K in November, below consensus expectations for 130K, and not much different from the revised 106K increase in October. Overall, that left the 3-month moving average at 99K jobs per month.

Note that prior to today's release the correlation coefficient between the change in private employment in the BLS data and the ADP data was -0.4, so not even uncorrelated, inversely correlated. We also have noted previously that the seasonality in the ADP in 2023 looks somewhat similar to 2022, with very strong summer months giving way to weaker autumn, though last November saw incremental strengthening. We stopped forecasting ADP when the methodology changed last year, limiting out of sample, real time experience with the data series.

In the details of today's report, goods employment dropped 14K, with manufacturing down 15K in November and 221K cumulatively since March. That November change is at odds with our expectation for a substantial boost to manufacturing employment in Friday's BLS November employment report due to the return of workers off payrolls during the UAW strike. Private service providing jobs rose 117K in November, about the same as in October. Strength was seen in education and health services and trade and transportation, and weakness in professional and business services and the leisure and hospitality sector, the latter recording a negative print for the first time since February ‘21. Note ADP does not estimate government employment, just private, compared to the BLS which estimates both, which combine to be nonfarm payroll employment.

The ADP report has no bearing on our expectations for an above consensus 190K increase in private employment in November, and a 220K increase in total nonfarm payroll employment. The current consensus of posts on Bloomberg is for a 187K increase. We previewed the data and potential Fed implications on page 16 of Friday's US Economics Weekly…

… And from Global Wall Street inbox TO the WWW,

Bloomberg: US Treasury Rally Is Starting To Look Long In The Tooth (kinda agree here)

By Simon White, Bloomberg Markets Live reporter and strategist

The rally in Treasuries is beginning to look tired. Yields are moving in lock-step with short-term rate-cut expectations, which are looking overcooked given the loosening in financial conditions has likely helped push the timing of the next NBER recession further out.

Treasuries are becoming progressively overbought after an impressive rally of over 5% since mid-October. The rally was not unexpected as it came off oversold conditions, but the pendulum has, as usual, swung too far in the other direction, where the drop in yields is hard to square with economic expectations.

The Treasury rally has been augmented by the Federal Reserve opening the door to rate cuts next year. Longer-term yields in theory should factor in the short-term rate cycle as well as future rate cycles, and other longer-term risks such as inflation.

In practice, though, longer-term yields move almost in lockstep with shorter-term rates. The chart below shows the very close relationship between the December 2024 SOFR and the 10-year yield. The correlation between the two is 80% (for a correlation of daily changes, that’s high).

Yields have fallen with the zeal of Fed rate-cut pricing. But the “everything rally” this has undergirded has led to a sizeable loosening in financial conditions. The implied rate cut from this loosening (based on Goldman Sachs’ Financial Conditions Index) looks like it may have already helped push a NBER recession further out.

The tightening in financial conditions last year and earlier this year that was historically consistent with previous recessions has been completely reversed. This chart suggests we will need to see a re-tightening of financial conditions before a recession.

As noted on Monday, positioning in Treasuries is potentially quite long (based on JPM’s survey of active clients). Further, it would almost be unprecedented for the Fed to cut by as much as the market currently anticipates, outside of a recession. Bloomberg Intelligence rate strategists think the market may be in for a shock if the Fed sticks to its guns at next week’s meeting:

A short UST view is not exactly contrarian, but that doesn’t detract from the fact that current rate-cut expectations — and therefore yields — require more bad news, and soon, as well as a supportive Fed. Also notable was the failure of USTs to extend their rise after a weak JOLTS report on Tuesday (even though it should be treated with great skepticism).

Bloomberg: The bull market is now all about 2024 rate cuts

In recent weeks, we’ve had an ‘Everything Rally’ with all asset prices rising. Despite nagging doubts about a recession in bond pricing, the gains are predicated on rate cuts preventing a worst-case scenario. But not everything can rally further from here. The outcome depends critically on the economy, with the time to pick an asset class to overweight quickly approaching. 

Bloomberg: The Market's Next Big Pain Trade (any predictions for the fight, Clubber … this one in full)

Authored by Ven Ram, Bloomberg cross-asset strategist,

Extreme Bond-Market Positioning Heralds Pain Trade

Disappointments are the deepest when just about everyone in the markets is positioned for the same outcome.

With the disinflationary narrative in the US evolving in line with the Fed’s estimates, traders are bracing for that definitive inflection point in the economy that will send Treasuries soaring. 

In fact, traders are clamoring for bonds relative to stocks at a pace close to the fastest in two decades, possibly setting a low bar for disappointment - and potentially making it the markets’ next big pain trade.

Options on longer-maturity Treasuries show that outstanding open positions that will benefit from a rally are almost 2.5 times as much as those that offer downside protection, hovering around a peak set in September.

In contrast, positions that will gain from a slump in equities are twice as much as those that seek upside, a sign that traders are braced for a correction after this year’s melt-up in stock valuations.

The lopsided positioning means that bond bullishness relative to stocks is near the highest in data going back to 2005, a reflection of conviction that an inflection point in the US economy is around the corner.

The extreme optimism toward bonds relative to stocks isn’t completely without merit.

Headline inflation that was running at 6.5% at the end of last year has since halved. Core PCE, the Federal Reserve’s preferred gauge, is now at 3.5% — less than the Fed’s year-end estimate of 3.7%.

That progress in the battle against inflation has spurred bets that the Fed will slash its benchmark rate by as much as 125 basis points by the end of 2024, which isn’t an implausible scenario.

While Chair Jerome Powell pushed back on suggestions of a premature policy easing last week, current rates may seem too restrictive should the disinflationary process become more deeply embedded in the economy.

That is as good as it gets for the current bond-market positioning.

Arguing against such bets are the US economy’s relative resilience and several credible estimates that the neutral rate may have reset higher in the aftermath of the pandemic.

It’s no secret that the economy has fared far better than policymakers estimated. The Fed, which forecast economic growth of just 0.5% for 2023 around this time last year, has since revised up its estimate to 2.1%. For next year, it projects growth of 1.5%, which would be below its own estimate of long-term trend growth of 1.8%. It also reckons that the jobless rate needs to climb from 3.9% now to 4.1% to bring the labor market into balance.

Prospects of a higher neutral rate will also deter the Fed from loosening policy too quickly. The Fed’s own researchers reckon that the rate — a nirvana policy setting doesn’t boost inflation while keeping the labor market going — has shifted higher.

Against this backdrop, the rally in Treasuries that has sent 10-year yields plunging by some 75 basis points from a cyclical peak of 5.02% looks to have gone too quick and too far.

The overwhelmingly skewed positioning in the markets read against a backdrop of a still-resilient economy suggests that traders’ high conviction has the potential to become the next big pain trade for the markets.

Daily Chart Report: Chart of the Day

Today’s Chart of the Day was shared by Brett Villaume (@brettvillaume). The US 10-year Treasury Yield ($TNX) dropped to a 3-month low of 4.11% today. It peaked in mid-October after reaching 5.00% for the first time since 2007. This decline in yields has fueled the recent rebound in stocks and crypto. However, Brett points out that $TNX is testing a potential inflection point, around 4.07%. This level coincides with the 200-day moving average, the March ’23 highs, and the uptrend line from the Aug ’21 lows. $TNX has every reason to bounce here, but if it breaks, it will send a very bullish message to stocks and other risk assets.

AT brettvillaume
Double secret probation for the $TNX! 50-day MA turned down. Now facing major support from 1) uptrend since 2021, 2) March 2023 peak, 3) 200-day MA.

AT FusionptCapital
I say this from time to time, prob worth repeating.

Your mind is essentially under constant attack. If you can recognize when and how, and combine it with some basic price action, markets (at the margin at least) get slightly easier to navigate.

AND fresh off our early morning ‘pre-game’ walk can’t confirm or deny that it went something like this but …

I DO read research as I’m listening to BBG TV so … maybe (or maybe not) :) … meanwhile as far as BNP on OPEC above, THIS …

AND … THAT is all for now. Off to the day job…