Services Growth Surprises Markets
The services economy is running hotter than anyone thought, with the February ISM reading of 56.1 significantly beating the 53.5 forecast. This strong data challenges the view that the economy is cooling enough for the Federal Reserve to consider rate cuts. We must now seriously question the market’s previous pricing for a summer rate cut. We should adjust interest rate derivative positions to reflect a more hawkish Fed for longer. This means we could sell SOFR or Fed Funds futures, as the probability of rate cuts in the second quarter has now sharply decreased. Looking at options, buying puts on treasury bond ETFs like TLT could also be a profitable strategy if yields continue to push higher on this news. The internals of the report, particularly the Prices Paid component which jumped to 61.2, suggests inflationary pressures are still very much alive in the services sector. This comes just after the January CPI report showed core inflation remaining stubborn at 3.4%, well above the Fed’s target. This combination of strong growth and sticky prices gives the Fed every reason to remain patient and hold rates steady. For equity indexes, this data is a headwind for rate-sensitive growth stocks. We should consider buying protective puts on the Nasdaq 100 (QQQ) to hedge against a valuation reset in the tech sector. The broader S&P 500 may see increased volatility, making strategies that profit from a sideways or choppy market more appealing in the weeks ahead. We saw a very similar pattern throughout 2024, when strong economic data repeatedly forced the market to push back its expectations for Fed rate cuts. During that time, positioning for “higher for longer” was the winning trade for months. We should not ignore the lessons from that period as this current data suggests that trend is reasserting itself.Implications For Dollar Yields And Risk Assets
The strong U.S. data should also provide a strong tailwind for the U.S. dollar. We anticipate the Dollar Index (DXY) will find renewed strength against currencies from regions with weaker economies. Therefore, we should look at buying call options on the dollar or put options on the Euro, as the European Central Bank is facing a much softer economic outlook. Create your live VT Markets account and start trading now.
Start trading now – Click here to create your real VT Markets account
