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Robust jobs numbers could mean smaller Fed cuts this year

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Expectations of lower rates have anchored trades across

markets

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Bearish bets on dollar at risk of unwind

By Saqib Iqbal Ahmed, Lewis Krauskopf

NEW YORK, Oct 7 (Reuters) - The reverberations from a

blowout U.S. employment number could threaten an assortment of

trades predicated on falling interest rates, if

stronger-than-expected growth spurs investors to radically shift

views on how much the Federal Reserve will need to cut borrowing

costs in the months ahead.

Expectations of steep rate cuts spurred bets on everything from

rising Treasury prices to a weaker dollar in recent months,

while juicing corners of the stock market such as utilities. The

Fed delivered a jumbo-sized 50 basis-point cut last month,

temporarily vindicating that view.

But the trajectory of rates is less certain after Friday's labor

market report, which showed the U.S. economy creating over

100,000 more jobs than expected last month. That suggests there

is less need for more large cuts this year and raises the

prospects of a reversal in many of the trades that hinged on

lower rates.

Futures tied to the fed funds rate on Friday showed

traders had ruled out another 50 basis-point cut at the central

bank's November meeting. Market pricing on Thursday reflected a

greater than 30% chance for such a cut, according to CME

FedWatch.

Here is a look at some corners of the market that could be

affected in a rates rethink.

DOLLAR REBOUND

Net bets on a weaker dollar stood at $12.91 billion in

futures markets last week, the highest level in about a year,

data from the Commodity Futures Trading Commission showed, after

the dollar notched its worst quarter in nearly two years.

But the dollar shot to a seven-week high against a basket of

currencies on Friday and may have more gains ahead if bearish

investors are forced to unwind their bets.

"Dollar bears had unquestionably gotten too far over their

skis coming into this week, and are now suffering the

consequences," Karl Schamotta, chief market strategist at

payments company Corpay in Toronto.

TREASURY REVERSAL

Bets on a stronger-than-expected economy could also

accelerate a recent rebound in Treasury yields. Yields on the

benchmark 10-year U.S. Treasury, which move inversely to bond

prices, hit a 15-month low of 3.6% in September, as investors

rushed to price in rate cuts.

That move has reversed in recent days. Yields hit 3.985% on

Friday, following the data, their highest level in about two

months.

Zhiwei Ren, portfolio manager at Penn Mutual Asset

Management, said the jobs report was a big surprise that went

against "consensus and crowded trades" in the Treasury market

that bet on bond prices rising as rates fell further.

HEDGE DEMAND

Expectations of economic strength could also push investors

to turn their focus from options hedges to chase further stock

market gains, spurring more upside in the S&P 500,

according to Charlie McElligott, managing director of

cross-asset strategy at Nomura.

As investors chase upside "it could quite rationally act as

the fuel for the melt-up to 6,000 and beyond," he wrote. That

would constitute a gain of about 4%.

In options markets, various measures of skew - a gauge of

relative demand for downside protection versus upside

speculation - have remained elevated after hitting their highest

levels of the year in an August stock sell-off, even as the S&P

500 recovered.

The benchmark stock index rose 0.9% on Friday and finished

at 5,751.07, near a fresh high.

"The rip higher post the massive Labor data 'beats' tells

you people don't have 'right tail' on," McElligott said,

referring to the possibility of an extremely large rise in stock

prices.

A countervailing force in the short term, however, may be a

too-sharp rise in yields that could dim the allure of stocks

compared to bonds, said Jeffrey Schulze, head of economic and

market strategy at ClearBridge Investments, in a note on Friday.

The 10-year yield is still about 100 basis points below where it

stood a year ago.

"However, this release should be positive over the

intermediate-term for risk assets generally and US equities in

particular as economic growth expectations should improve on the

back of today's release," he added.

BYE TO BOND PROXIES?

Investors may also need to rethink trades in some stock

sectors that came in to favor as yields fell.

Among those are the market's bond proxies, high

dividend-paying stocks in sectors that had grown popular with

income-seeking investors as yields fell. One such area, the S&P

500 utilities sector, is up 28% year-to-date, compared

with a 20.6% gain for the S&P 500.

"The economy may not be in as much trouble as people were

worried about, and it may not need these large rate cuts that

fueled the interest in the higher-yielding areas of the market,"

said Robert Pavlik, senior portfolio manager at Dakota Wealth.