Top of the Morning: CIO Strategy Snapshot - What’s driving the markets?
The desk interprets the recent resilience in financial markets, despite the U.S. government shutdown, as a reflection of underlying investor confidence and positioning. Per the full note from UBS, the labor market data has suggested that the economy remains robust, even amid uncertainty. This resilience appears to be supported by the fact that both equities and bonds closed positively last week, underscoring a broader sentiment that markets might be pricing in limited immediate fallout from the political standoff. A nuanced understanding of the labor data and how it interacts with ongoing fiscal debates will be critical in navigating upcoming sessions.
What the desk is arguing
The desk believes that investor confidence is currently driving market resilience, despite the ongoing U.S. government shutdown and lack of economic indicators. Per the full note from UBS, Jason Draho emphasizes that market participants seem unconcerned about the political stalemate, with both equities and bonds positive over the past week, suggesting a degree of complacency or faith in economic fundamentals.
High-frequency indicators, especially from the U.S. labor market, have shown solid performance recently, with key metrics pointing towards a tight job market that supports consumer spending and economic stability. Although specific numbers weren't cited in the commentary, the inference drawn from the labor market's health is clear: it acts as a buffer against the risks posed by the shutdown.
Any shift in political dynamics could erode this confidence. However, the current enthusiasm suggests that traders are currently willing to overlook potential downturns, maintaining their positions in riskier assets based on optimistic labor data.
Where it sits in our coverage
The desk’s view aligns with a consensus target for USD/CAD at 1.075, edging towards the upper boundary of the consulted forecasts. Key targets include:
Given that the desk’s position reflects a more bullish stance, this may place it towards the higher end of the forecast range, suggesting a market anticipating slight upward pressure on the USD against CAD.
How other firms see it
Several firms align with the bullish sentiment on the U.S. economy and its ability to weather political turmoil, such as jpmorgan, while bofa maintains a more cautious outlook regarding USD/CAD, positioning for a potential drop.
All eyes will be on any new labor market reports or data releases that could further elucidate this discourse, particularly with respect to employment figures and wage growth, which are pivotal for influencing USD positioning and market dynamics.
01Despite the U.S. government shutdown, financial markets showed resilience last week.
02Investor confidence is underpinned by strong labor market indicators, suggesting economic stability.
03Political negotiations impact market sentiment, with traders watching for shifts.
04The market is currently pricing limited immediate fallout from fiscal uncertainties.
Market implications
Traders should monitor labor market data closely, as any signs of weakening could lead to volatility. Additionally, watch USD/CAD, particularly if the pair approaches the 1.075 mark; this could signal further interest in risk assets amidst the current economic optimism.
Risks to this view
Should the political stalemate extend significantly, or if labor market data signals deterioration, this could lead to a recalibration of risk appetites, potentially reversing the current bullish trend in equities and impacting USD positions adversely.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. The U.S. federal government shut down last week, but the financial markets gave a collective shrug in response with both stocks and bonds finishing up on the week.
The shutdown is now entering into day six and a resolution doesn't appear imminent. That means investors will be navigating the markets with less information than usual for the time being. So joining me here today in studio to discuss the shutdown, the economy and the markets.
Glad to welcome back from the UBS Chief Investment Office, Head of Asset Allocation for the Americas, Jason Draho. Jason, good Monday morning to you. Thank you for dropping by and for spending some time with our listeners and their clients.
Welcome back. It's good to be back. Happy Monday.
Happy Monday. So Jason, let's start with the government shutdown. As mentioned, as we're recording today on October 6, the shutdown has entered day six.
So what are you watching for with respect to signs of a resolution in the hours and days ahead? Well, to reach some sort of deal, both Republicans and Democrats have to presumably give up something or agree to something. So the question really is, from their perspective, like what's the political calculation in which they're willing to acquiesce on some demands that they're making, you know, to get a deal done?
And that kind of boils down to, sometimes politically, do they think they're kind of winning or not? You know, like are they going to be perceived as the winners or losers if this kind of drags on too long? Who's the public going to blame?
There's multiple polls out there showing by and large, more voters are blaming the Republicans than Democrats, which given that Republicans have both the House, the Senate, and of course the White House, that's sort of understandable. And voters appear to be blaming Republicans two to one. So the moment the blame is going in that direction, whether again, how much that matters, you know, remains to be seen.
But that's one kind of consideration. The thing about what is it that the Democrats in particular want, it's for the subsidies or tax credits for Obamacare to be extended, and that is also kind of getting some traction. So politically, you know, where do they think it's kind of in their best interest to kind of hold out, that seems to be getting some sort of traction.
On the other hand, you know, Republicans, you know, with President Trump and one of his key advisors, Russell Vogt, is out there basically saying like, you know, if we don't get a deal, we're willing to cut entire departments or cut a large percentage of the furloughed workers. And this is an administration based on their actions this year that you have to take them somewhat at their face value. Again, were they willing to go through with that?
Because if they do, the economic consequences, the headlines might be further there kind of owning it. So this is a bit of the brinksmanship. There had been votes essentially every day in the House and Senate.
And there was thought that this would happen kind of every other day. Speaker Mike Johnson for the House kind of came out and said there will be no votes this week. Of course, that could change by lunchtime today.
But that's kind of where it is. So they'll probably be kind of somewhat regular votes. It's important to note that in the Senate, right, the Republicans have 53 versus 47 seats.
It has to pass by 60, you know, votes in the Senate to get through. 53 Democrats last week before the shutdown voted on a deal that would have kept the government funded. One Republican didn't. So it was 55-45.
So five more Democrats would have to kind of peel away to vote with them, Republicans to kind of get this through. How long, again, like individually some might want to hold out. If you're in a swing state, if you're up for re-election next year, that may be a consideration where some Democrats either like, this is working for me or not, right, that, you know, that could be goes back to the political calculation.
In terms of timing, like there's nothing that would necessarily force the government to reach some sort of deal. There is more other than sort of optics. On October 15th, it's a military payday.
So it's usually sometimes there's been partial government shutdowns where the military still gets paid. In this case, they wouldn't. There could be certainly a desire among both parties to not be seen as not funding the military.
You know, who, again, politically that'd be viewed as more critical. That's debatable. You can kind of make cases for both.
So it looks like at the moment, given where things stand, there's probably not a deal likely today. I mean, you can never rule these things out because suddenly there's going to be some sort of breakthrough at any point in time, at least to fund the government for like another month or two months, something like that. But I think the risk is that this thing extends at least for another week, which means another week of no data.
And for the markets, you know, that if we get past October 15th, that's when CPI data would come out. Then it starts to kind of run the risk of like, well, the data for October also be impaired because collection periods start to become impacted as well. So this is kind of how it's likely to play out.
Ultimately, we know it's going to be resolved and probably resolved by early November just based on history, if not sooner. And I think given that without a lot of pressure, there's no reason why we'd expect a deal to be imminent. For the moment, it's not having major economic impacts.
And as you mentioned at the start, the markets kind of shrugged it off for the most part last week. So a lot of wait and see as lawmakers continue to work through this. Now, normally on this podcast, Jason, as you know, early in the month, we do spend some time discussing the payrolls report and what that says about the U.S. economy.
Now, we don't, of course, have that data at this time, though, based on the data we do have, how would you assess the state of the labor market and the economy at the moment? Well, we did get various labor market data last week, which collectively would kind of reinforce the narrative that's been in the market for a little while now, which is we have a labor market that seems to be in a holding pattern. And what some would characterize as a no hire, no fire kind of situation.
So on that front, you know, JOLTS data, which is the job openings, that was released on September 30th for August. So we did get it just in time. The number of job openings went up slightly, net positive, but also the number of unemployed workers has gone up a little bit.
So the ratio that I think that's critical to get a sense of labor market balance or imbalance is the ratio of job openings to unemployed. And that actually went down a little bit. Now it's less than one.
So there's slightly fewer job openings than people looking for work. This has kind of been trending lower steadily since, well, 2022, when it peaked at two. This is during the Great Resignation, the massive amount of job openings, and not many people were unemployed or looking for, or at least not nearly as many people were looking for work.
I think a better context is where was this measure prior to the pandemic beginning back in 2019, early 2020, and it was running around 1.2. So definitely signs of the labor market kind of softening overall, but nothing changes the overall narrative. ADP, it's a private company that collects data, payroll data, and they have a monthly number that comes out for September, it was minus 32,000.
That was the third negative month in the last four. So again, reinforcing softness that wasn't dramatically lower than other months. It certainly wasn't positive, but kind of fuels this view that job growth is just very tepid at this point in time.
There was no initial jobless claims number on Thursday morning, but individual states do release data, and aggregating those up can give a pretty decent proxy for what the national number would be. And those estimates also suggest no real uptick in initial claims, again, a little bit higher, but all within sort of the range of kind of noise. So consistent, again, with no fire, hiring is weak, a labor market that's holding steady.
So that narrative hasn't changed, and again, it's only been three days of at least economic data in terms of the shutdown. Other data continues to show a relatively resilient consumer, and growth estimates still tracking, you know, for the Atlanta Fed, up to almost 4% for Q3, and other economists nearing the 2.5% to 3% range. So the narrative overall of an economy that softer labor market, but recession risk remains low, that still seems to be the dominant view.
And we're not going to get, as I say, a ton of data, you know, at least in the next week or so that would alter that view. Okay, so despite not having the full picture, there are still indicators out there, which investors, analysts can point to, to get some sense of what the health of the labor market looks like. So it's interesting how this all translates to the markets.
I mentioned, Jason, how the markets were up last week, despite the shutdown. So what does that say about what's driving markets at this time? Well, equities overall were up, you know, bonds were up a little bit.
So it was kind of a positive story across the board. For equities and risk assets in general, you know, there's a few different things that we can kind of point to. One is that there's been strong momentum for equities and sometimes, you know, simple kind of logic that the path of least resistance is that the markets go higher in the absence of new news or something that would change the overall narrative, that momentum kind of continues.
Or in physics, physics, you know, the object in motion stays in motion unless it's disturbed in some capacity. So there's just, the bias is, if the market's going to go one direction or the other, more likely it's going to go up given the recent momentum, unless something kind of, you know, suggests that it should go down. Now the data that we're not getting from the federal government is a snapshot or gives an indication of how the economy overall is doing.
But there is other drivers to the market, in particular, AI continues to be a, you know, has been a strong driver of the market performance overall. You know, every week there seems to be a different catalyst, whether, you know, a few weeks ago, Oracle reporting numbers that were far, you know, higher than expectations, in part because of the, you know, their investment in cloud related AI spend. Last week, semis had a strong week, they were up, the Sox semiconductor index was up over 4%, but also South Korea semiconductors, whether it's, you know, Samsung and others were up significantly, not just last week, but for the, over the past month, like upwards of 30, 40, 50%.
So that was another kind of positive, you know, kind of catalyst driving the market's higher last week, just that that theme continues to, you know, to have momentum. A third factor is, you know, investor flows and positioning continue to have strong retail participation in this market. They're definitely kind of buying funds into flows into ETFs continue to be strong.
So there's a technical aspect to this overall, you know, kind of performance as investors continue to put, you know, capital work. And if we look at what did well last week, it was the more speculative parts of the market. So small caps outperformed large caps, like the Russell 2000 was higher than the S&P 500.
Baskets of stocks, you know, different firms will kind of put these together, these baskets of say, you know, high risk stocks or, you know, higher default risk stocks, and they were all kind of outperforming last week. Non-profitable tech kind of a proxy for, you know, kind of more speculative parts of the market also kind of bouncing a lot. So again, speaking to investors, just willingness to take some risk last week as well, despite the absence of kind of some of the government issued data.
Bond yields did decline a little bit, you know, which is why bond returns are positive. All sequel lower yields tends to boost risk assets. So there was that sort of just mechanical aspect to it, you know, overall.
And then a further catalyst that this is more overnight, it didn't matter for last week so much, but there was a new Japanese government and their bias is to have more kind of fiscal expansion, more dovish, you know, central bank or Bank of Japan. And as a result, you can see like Japanese equities up 5%. So there are sort of global stories, it's not just a U.S. story, that are also being kind of tailwinds for risk assets overall.
Okay, so a variety of factors supporting this market momentum at the moment. So based on these considerations, Jason, what are your main investment recommendations at this time? How should investors be positioning?
Well, I mentioned the growth narrative, the macro narrative has not really changed. Again, this is a relatively short period of time. So there's nothing that would sort of alter our overall kind of messaging.
You know, on equities, bottom line, we think this is a bull market, and they'll grind higher over the course of next year, there will be sometimes pockets of vulnerability. But I kind of focus on some of the key themes. I already alluded to how last week AI sort of tech, you know, that theme kind of played out with semis last week.
And today, you know, open AI is having sort of a developer day. So there could be another kind of news flow that comes out of that could begin sort of being a positive catalyst. So that continues to be kind of a favorite way to position these markets.
Banks and financials are something we like, banks in particular, you know, with a macro environment that looks relatively constructive, certainly going into next year, Fed kind of rates, yield curve steepening. But a key catalyst for us was the deregulation trend that towards allowing banks to unlock capital, deploy capital, increase earnings per share, things of that sort, more buybacks or, you know, kind of returning cash to shareholders. As part of that could also be more deal flow, a kind of looser or more approval of M&A activity to have sort of consolidation.
And we saw that actually this morning, this is Monday morning, that first third announced an acquisition of Comerica for $10.9 billion. This could be a sign of a kind of logjam of deals that have been set on hold, starting to kind of break. And this is kind of consistent with a more conducive regulatory environment for banks, certainly, but, you know, in general.
But that's another thing that we like. And this is kind of a proof point of that kind of thesis overall. So that's kind of what we like in equities and fixed income.
You know, a message we had for a while is kind of, you know, stay high quality. I think that was sort of validated by some of the news last week where First Brands, which is an auto parts supplier, filed for bankruptcy. It had roughly $5 billion of, you know, kind of lending to it, private credit, but it was more kind of like supply chain and sort of, you know, kind of inventory, like financing.
You can kind of parse the details, but the bigger picture is that your spreads are incredibly tight. IG spreads are tight. High yield spreads are tight.
But there are risks out there that their default rate is still running at 4%. We don't necessarily think it's going to tick up. There are inducing factors to this one particular default.
But it's a reminder, there is credit risk and you're not getting paid a lot for taking credit risk at this point in time, which is why, again, we say kind of go up in quality overall. Something else we can hear like is gold as a diversifier, sort of as a kind of a good way to place of a de-dollarization trend. The idea that investors will look at what, you know, the fiscal situation in the U.S., questions, I mean, about the Fed's policy going forward, you know, political calculations and think, well, I want to own less U.S. assets.
What else do I buy? Gold is a key beneficiary. It's also a beneficiary from just in general this push towards kind of fiscal expansion, looser monetary policy.
And what we saw, again, is gold is up this morning, you know, over 1% on primarily news of Japan. No concerns on the price point of gold? No.
I mean, we've upgraded our price targets. So we continue to see this tailwind of, as you see, more governments looking to, you know, deal with fiscal expansion, easier monetary policy, large deficits that aren't going to be necessarily addressed in the near term, then gold is a good diversifier against that. And we saw that again this morning, I think, on the Japan news because the new prime minister is expected to pursue something that is more of a reflationary, demand-driven sort of, you know, inflation.
If that happens, again, that's, you know, gold is a beneficiary and the market response at this point is consistent with that. That's one of the reasons why we like it as a diversifier. Well, Jason, helpful touch base as always.
Thank you for dropping by to begin the trading week with our listeners, our clients. We'll see what happens in D.C. this weekend. As always, do look forward to our next conversation.
You're welcome. Have a great week. Thank you, Jason.
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