Stocks Drop as Investors Bet the Fed is Behind the Curve in Cutting Rates

Also, 10-year T-note, gold, crude oil and Japanese yen futures

1. Nasdaq 100 E-mini futures (/NQ): -2.07% 

2. 10-year T-note futures (/ZN): +0.83% 

3. Gold futures (/GC): +1.17% 

4. Crude oil futures (/CL): -2.95% 

5. Japanese yen futures (/6J): +1.52% 

The recession is nigh—at least that’s what the July U.S. jobs report may be telling markets. The U.S. labor market showed unexpected signs of deterioration last month, with headline jobs growth coming in at a meager 114,000 vs. 175,000 expected. The unemployment rate (U3) jumped from 4.1% to 4.3%, while wages came in weaker all-around at +0.2% month over month (m/m) and +3.6% year over year (y/y) vs. +0.3% m/m and +3.7% y/y expected. 

The surprising miss on the headline, coupled with a small uptick in the labor force participation rate to 62.7% from 62.6%, was enough to push the unemployment rate (U3) high enough to trigger the Sahm rule. The rule suggests a recession has started once the unemployment rate rises by more than 0.5% relative to the minimum of the three-month averages from the previous 12 months. The July jobs report puts the Sahm Rule indicator at 0.53%. 

In a post-July Federal Open Market Committee (FOMC) world where “bad news is bad news,” the July U.S. jobs reported sparked another leg lower across equity markets, with both the S&P 500 and Nasdaq 100 breaking uptrends from the October 2023, April 2024 and July 2024 swing lows. Bonds, on the other hand, loved the data, but that’s not a surprise: Since 1980, long-term U.S. Treasuries have been the best performing asset class during recessions. 

U.S. equity markets did not like this morning’s jobs data despite the way it’s amplifying the chances, and now increasing the odds for a larger, interest rate cut. The risk aversion comes as recession odds increase, with traders betting the Fed is behind the curve. Amazon (AMZN) is down nearly 10% in pre-market trading after missing revenue guidance yesterday. Apple (AAPL) managed to beat estimates, but it performed poorly in China, dragging the stock over 1% lower ahead of the bell. 

The steepener trade is in full effect after this morning’s jobs numbers. The spread between the 10-year and two-year Treasuries nearly uninverted after the short-end of the yield curve plummeted. Typically, the yield curve uninverting signals a recession. The 10-year T-note futures contract (/ZNU4) rose nearly 1% to trade at the highest levels since January.  

Gold is back in the spotlight with recession risks forming and the Fed prepared to cut rates. Historically, a drop in U.S. Treasury yields bodes well for precious metals, particularly when financial markets are gearing up for recession. In fact, after Treasuries, gold has produced the highest return on average in recessions since 1980 (7.1%). The period of expanding volatility is consistent with rallies in precious metals, so active investors looking to fade recent moves may want to exercise more patience. 

Demand for oil and global growth have a +0.92 correlation on a quarterly basis over the past 30 years. The unexpected miss in the July U.S. jobs report speaks to weakening aggregate demand in the world’s largest economy, which is bad news for energy markets no matter how you slice it. Looming geopolitical risk between Israel and Iran is being overlooked; given the backdrop of rising concerns of a global recession, it stands to reason that any rallies in crude oil (/CLU4) should be faded. 

Collapsing interest rate differentials on the back of surging U.S. Treasuries is hurting the U.S. dollar. The top performer is once again the Japanese yen (/6JU4) as foreign-exchange (FX) markets are reaching for liquidity. Given broad weakness in growth-sensitive assets elsewhere, it remains to be seen for how long rallies in the Australian dollar (/6AU4) and Canadian dollar (/6CU4) may last. 

Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx

Thomas Westwater, a tastylive financial writer and analyst, has eight years of markets and trading experience. @fxwestwater

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