Trading Day: AI, Fed bets sweep aside shutdown jitters

By Jamie McGeever

ORLANDO, Florida (Reuters) -TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

Stock markets around the world leaped to new highs on Thursday, propelled by optimism around the AI boom and hopes for further U.S. interest rate cuts, as investors shrugged off the U.S. government shutdown which entered its second day.

More on that below. In my column today I look at why the U.S. government shutdown is the last thing the Federal Reserve needs right now - visibility around the labor market and inflation for data-dependent policymakers was already limited, and this just reduces it even more.

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. With the U.S. government dark, alternate sources show asluggish September for jobs 2. Prolonged U.S. government shutdown could raise marketrisks 3. Sign of the times as Swiss buy euros not dollars: MikeDolan 4. OpenAI hits $500 billion valuation after share sale toSoftBank, others, source says 5. China's 'new economy' shines through cloudy growthoutlook: Raychaudhuri

Today's Key Market Moves

* STOCKS: Record highs for S&P 500, Nasdaq, world stocks,Europe, euro zone, Britain, South Korea, Taiwan. MSCI AllCountry index is now up 18 of the last 22 trading sessions. * SHARES/SECTORS: Biggest S&P 500 sector gainer ismaterials, +1%; biggest decliner energy, -1%. Broadersemiconductor index +2% to new high. Coinbase shares +7%, Tesla-5%. * FX: Dollar snaps 4-day losing streak, gains most vs NOKas oil price slides. Bitcoin at 10-week high above $121,000. * BONDS: U.S. Treasury yields drift to 2-week lows inthin, shutdown-dominated trade. Curve bull flattens a couple ofbasis points. * COMMODITIES: Oil down another 2% to new 4-month lows,gold and silver hit fresh peaks.

Today's Talking Points:

* The AI Emperor - clothes or no clothes?

OpenAI, the company behind ChatGPT, has reached a valuation of $500 billion following a recent share sale, making it the most valuable private company in the world. That's up sharply from its current valuation of $300 billion. Where next? $1 trillion?

It's a landmark moment but raises familiar questions about whether the AI boom is a bubble. AI-related capex spending in the U.S. is soaring but a lot is on imports, so is actually an offset to GDP growth. And the bar for future returns is high. But as long as the music is playing, investors will keep dancing.

* What's going on with oil?

Oil prices are sliding. Fast. Brent and WTI crude futures are down nearly 10% in the last week, scraping four-month lows of $64.00 and $60.40 a barrel, respectively, as oversupply concerns grip the market.

OPEC+ countries meet this weekend and could agree to raise oil production by up to 500,000 barrels per day in November, sources tell Reuters. That would be triple the increase for October. Oil's disinflationary momentum is building.

* De-dollarization - a bit of a myth?

IMF figures this week showed that the dollar's share of global foreign exchange reserves in Q2 dipped to 56.3% - the lowest since at least the euro's launch in 1999 - from 57.7% in Q1.

But adjusted for exchange rates, the dollar's share held steady, the IMF said. According to Goldman Sachs, it actually rose for the second quarter in a row, and as capital flows expert Brad Setser notes, the official sector's nominal dollar holdings in recent years have been "basically constant". So no de-dollarization then, at least from central banks.

U.S. government shutdown gives Fed last thing it needs - even less visibility

After the Federal Reserve resumed its interest rate-cutting cycle last month, Chair Jerome Powell signaled that incoming U.S. economic data would play an even more critical role than usual in determining the central bank's next steps. But the government shutdown means the Fed may now be walking blind.

"We're in a meeting-by-meeting situation, and we're going to be looking at the data," Powell told reporters after the 25-basis-point cut on September 17, adding: "There are no risk-free paths now."

Those paths have just gotten a whole lot riskier.

The government shutdown that began on Wednesday could delay the release of a large chunk of economic data, meaning the Fed's ability to accurately assess the labor market and inflation situation – which was already limited – will now be much worse. That, in turn, could make the market rethink its own conviction about the near-term rate outlook.

Key employment and inflation data are set to be delayed, namely weekly jobless claims from the Labor Department, and all-important monthly non-farm payrolls and CPI inflation reports from the Bureau of Labor Statistics.

The September payrolls and CPI inflation reports are due for release this Friday and October 15, respectively. They would probably be the biggest single influences in rate setters' decisions at the October 28-29 Federal Open Market Committee policy meeting.

As Rabobank analysts note, thick with understatement, this is "very inconvenient" for the Fed as these two data points could potentially tilt the balance between the hawks and the doves on the FOMC.

The FOMC's September 'dot plot' showed a median estimate of two more rate cuts this year, but it wouldn't take much to change that. The split of views showed that nine of the FOMC's 19 members expect only one more cut - or none - by December.

There is a clear polarization of views. Does a shutdown strengthen the doves' hand?

DATA QUALITY DOUBTS GROW

A quarter-point cut in October is already fully priced into rates futures markets. Another "insurance" cut, as Powell described September's move, would make sense - better to avoid the risk of falling behind the curve and being forced to ease more aggressively later.

This is particularly true in the event of a prolonged shutdown, which could put a 50-basis-point cut on the table in October or December.

Oxford Economics chief U.S. economist Ryan Sweet estimates that even a partial shutdown reduces GDP growth by 0.1-0.2 percentage points per week. To put that into context, the longest shutdown on record of over 35 days in President Donald Trump's first term would reduce fourth-quarter real GDP growth by 0.5-1.0 percentage points.

But there's also a compelling case for not easing at all, never mind pouring fuel on the fire with cuts made in a haze of uncertainty rather than on data-led evidence, as Powell has insisted upcoming decisions will be based.

The hawks' base case appears to be strengthening - GDP growth is running close to 4% on an annualized basis, inflation is nearly a percentage point above target and showing few signs of cooling, and Wall Street is at record highs. It's unclear whether a government shutdown of a few days, or even weeks, would weaken the hawks' narrative.

One thing that most policymakers and economists do agree on is that the quality and reliability of U.S. economic data are deteriorating, in no small part due to falling response rates to surveys. This leads to skewed or inaccurate results, and more and bigger revisions.

Economists at Goldman Sachs estimate that standard errors are 26% higher on average today than in 2015-2019, and have increased for eight out of 10 government surveys they review. Labor market data appear to have been affected most by falling survey response rates, they note.

"This is an old problem, and old solutions continue to be relevant today: gather more data," Anna Kovner, director of research at the Richmond Fed, concludes in an article published on Wednesday.

That, of course, will have to wait, probably until long after the shutdown is over. Is patchy data preferable to no data at all? We could be about to find out.

What could move markets tomorrow?

* Australia PMI (September) * Japan PMI (September) * Japan unemployment (August) * Bank of Japan Governor Kazuo Ueda speaks * UK PMI (September) * Bank of England Governor Andrew Bailey and EuropeanCentral Bank President Christine Lagarde speak at same event * Euro zone producer price inflation (August) * Euro zone PMI (September) * U.S. services ISM (September) * U.S. PMI (September) * U.S. Federal Reserve officials scheduled to speak includeNew York Fed President John Williams, Dallas Fed President LorieLogan, and Vice Chair Philip Jefferson

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

(By Jamie McGeever; Editing by Nia Williams)