Stocks rise into payrolls risk

Summary

European markets rises to catch up with Wall Street ahead of closely watched monthly U.S. jobs data.

Europe-U.S. gap attracts buyers

The widening performance gap between European and U.S. stock markets (the latter besting the former)—on both short- and medium-term bases—partially accounts for buyers being attracted back to European markets on Friday. Some investors are being tempted to recycle gains into select bargains. Key European gauges face losses for the week whilst the S&P 500 and Nasdaq are likely to book gains. Apple’s largely symbolic milestone of reaching a $1 trillion market capitalisation generated enough positive sentiment to offset the latest ratchet higher in U.S.-China trade tensions. The news also encourages buyers to return to some of the iPhone maker’s suppliers listed in Europe, lifting technology sectors more broadly.

RBS adds to bank sector gains

The announcement of RBS’s first dividend in a decade enables its shares to join other large European banks even after the UK lender reported the latest in a long series of messy earnings. These included a £1bn charge related to the settlement of residential mortgage-backed securities mis-selling in the U.S. RBS also reported a further £800m in litigations costs. Regulatory approval to resume dividend payments was conditional on the DOJ settlement so the news was not surprising. However, attributable profit for the second quarter was £96m when a £741m loss was widely forecast, taking interim profits to a solid £1.8bn. Firm second-quarter figures from Credit Agricole also underpinned Europe’s banking sector, in turn contributing to overall gains. All industry sub-index components of the broad STOXX 600 trade higher.

Head-spinning week

Still, this snapshot contains enough vulnerability for signs of caution to remain quite visible: note a fleeting dip into the red by U.S. futures earlier on. It has after all been another head-spinning week with more salvos of trade rhetoric juxtaposed with another grind higher by the dollar. Further disturbing indications came from China’s yuan. Under pressure for months due to the trade dispute, it slid a further 0.4% to as low as ¥6.8926 on Thursday, a new 14-month bottom.

Dollar challenge for risk appetite

And it is dollar strength that could turn out to be the key remaining challenge to risk appetite at the end of the week. After the Federal Reserve managed to squeeze more optimism into its statement despite leaving policy unchanged, the barrelling greenback is on its second straight weekly advance. Given the stop-start nature of the rise from a more than four-year low in January—the dollar index has not had three consecutive rising weeks since the end of May—the greenback may soon pause. Either way, a stock market reversal earlier in the week was partly triggered by that new quantum of dollar strength. This suggests a tipping point could be near. One perception is that countries with current account deficits face even tighter dollar financing on top of deepening trade animus. Furthermore, at some point, investors in U.S. multinationals will begin worrying about export demand again, as well as possible drag on commodity prices. Friday’s non-farm payrolls release will be an important inflection point

Slight pain-trade risk from payrolls

ADP’s private payrolls data beat expectations with 219,000, weekly jobless claims were lower whilst ISM’s manufacturing sector employment PMI beat expectations. This time, forecasters lack the usual input from ISM’s reading of the much larger U.S. service sector. But even without that, risks are pointed topside for payrolls. Reuters’s poll points the headline at a 190,000 rise after 213,000 in June. Unemployment is expected to fall to 3.9% from 4%. The figures markets are most sensitive to, average hourly earnings growth rates, are seen at 0.3% month-on-month from 0.2%, and unchanged at 2.7% yearly. To be clear, the dollar will need these metrics to turn out indisputably strong to extend near term gains. Positioning seems to back this: the latest CFTC data showed dollar longs at their highest since January 2017. The dollar index looks set to rise at least 0.3%-0.5% this week. That suggests long positions are even now greater. Thus a 200,000-plus payrolls print is unlikely to entice bulls further. A moderately severe miss – say under 170,000 – could trigger a shake-out. Thus, the pain-trade risk looks relatively slight. However, with the dollar finding more pretexts for further gains than losses right now, we expect markets to be on alert for more of the former.