Softer US labour data and easing inflation have reduced the pressure for further Federal Reserve tightening, leaving policy expectations more focused on whether growth is slowing in an orderly way. Attention now shifts to services activity, with Monday’s S&P Global Services Purchasing Managers’ Index (PMI) and ISM Services seen as the main tests for the near-term path for rates, alongside a handful of Fed appearances.
Last week’s weak non-farm payrolls (NFP) reading raised the prospect that labour demand is cooling after a run of stronger payrolls, prompting a reassessment of how much further the Fed may need to hike. A softer set of services prints would support the view that the Fed is not inclined to move immediately and could extend the recent easing in front-end yields, while firmer readings would argue for caution in drawing conclusions from a single soft NFP report. In emerging markets, positioning is described as rotation rather than retreat, with higher US yields driving a reassessment of crowded bond exposure.
Market Validation and Key Services Data
We believe the market is now looking for validation after recent relief. Softer jobs data from last Friday, where the economy added only 110,000 jobs against an expected 180,000, and cooling inflation have reduced the urgency for more rate hikes. But now we need to see if this slowdown is manageable or if policy expectations have moved too far.
This week, the most important releases are the S&P Global PMI and ISM Services reports. These will help us determine if last week’s payroll weakness is showing up in broader activity. A consensus forecast for the ISM Services index is currently sitting around 53.0.
Should these reports come in softer than expected, it would strengthen the case that the Federal Reserve is done hiking for this cycle. We would look to position for lower front-end yields by using options on SOFR futures or buying 2-Year Treasury Note futures. This move would anticipate the market fully pricing out any remaining tightening bias.
Positioning for Services Surprises and Currency Impact
Conversely, a firm reading above 53.0 would argue for more caution and suggest last week’s jobs report might have been an outlier. This would remind us of similar head-fakes during the 2022-2023 tightening cycle where a single data point did not signal a new trend. In this scenario, we would consider buying puts on bond futures as a hedge against yields moving higher again.
The CBOE Volatility Index (VIX) has fallen to around 13, suggesting a degree of market complacency. This makes buying options relatively inexpensive, offering a cost-effective way to position for a surprise in the services data. We see this as an opportunity to build protective positions against a sharp reversal in rate expectations.
On the currency front, a weaker set of services prints would likely put significant pressure on the US dollar. We would express this view by buying call options on the EUR/USD or put options on the USD/JPY. These trades would benefit from a flight from the dollar as rate differentials move against it.
