The Great Rotation Cont.

The weekly roadmap for 09/01-09/07

Hello Everyone,

I hope you’re all enjoying the long weekend and taking some time to unwind away from the markets. As August comes to a close, it’s been an eventful month with significant market movements. We've seen everything from the Bank of Japan hiking rates and the unwinding of carry trades to growth slowdown fears and concerns over a potential recession. Earlier in the month, the market experienced a sharp decline with indices down over 7% at one point, fueled by aggressive rate cut pricing and the short volatility trade imploding. Yet, here we are, wrapping up August with all major indices in the green for the month and the Dow reaching a new all-time high.

Economic Data for the Coming Week:

Looking ahead to this week, it’s a crucial period for the Federal Reserve as we’ll get a clearer picture of the labor market and overall economic health. This data will be instrumental in determining whether the Fed might surprise the market with a 50 basis point cut in September or stick to the more expected 25 basis point reduction. While there’s a mix of economic and labor market data being released throughout the week, the focal point will be Friday’s jobs report. The last report showed the unemployment rate (UER) ticking up to 4.3% and job growth slowing to around 100,000, which spooked the markets and triggered early August’s sell-off amid recession fears. Since then, economic data has improved, but this week will be the ultimate litmus test.

Reflecting on Recent Market Behavior…

In the past few weeks, the S&P 500 has been stuck in a range, balancing for over 10 days now. The key question this week is whether the unemployment rate continues to rise significantly, reigniting growth and recession fears, which could push the market back into a risk-off mode. Alternatively, if the “soft-landing” or “Goldilocks” scenario holds, we could see the S&P 500 break out to new highs.

Despite the earlier panic in August over growth concerns, recent data has sparked renewed optimism for a soft landing. However, this optimism hinges on what happens next. If the unemployment rate increases meaningfully, the Fed might opt for a more aggressive 50 basis point cut in September, which would negate the recent optimism and be detrimental to risk assets. On the other hand, if the unemployment rate remains steady or even declines, the Fed could stick to the expected 25 basis point cut, allowing the current market dynamics to continue.

Interestingly, despite all the volatility and fear throughout August, the 10-year yield has held steady around 3.8%. The big question is what happens if economic growth continues to rebound while the Fed cuts rates, potentially shifting the focus from recession risks to inflation risks. Such a scenario could lead to a challenging market environment ahead.