Except JGB’s

All government bonds
Are under pressure today…
Except JGB’s

While markets are now anxiously awaiting the payroll report, a key underlying feature of markets this morning has been the virtual global rout in government bond markets. Yields are higher throughout Europe; with German bunds trading at their highest yields in almost three years while UK gilts are back to their highest yield since before the Brexit vote in June 2016. Of course, you are well aware of the ongoing rise in US yields, with the 10-year touching 2.80% yesterday and hovering just below there as I type. Which brings us to Japan, where JGB yields bucked the trend of rising yields. Of course, the reason is because the BOJ was actively intervening in the market overnight, buying JGB’s as part of their yield curve management program. So just when traders were thinking that even the BOJ was going to lean toward tighter monetary policy, the reality shows that there has been no such shift in view from Tokyo. This matters to our view of currencies because the widening yield premium of Treasuries over JGB’s has been enough to underpin USDJPY’s move higher by more than 0.5% this morning. This has been the biggest mover in the G10 space, although the dollar is firmer against all of its counterparts here. Perhaps what is most interesting about this market movement has been the sudden increase in articles describing all the reasons why the bond market rout may continue. By now I’m sure you all know that I believe yields around the world are going to rise, its just that I believe that US yields will be rising faster than others, and more importantly for the dollar, faster than currently priced by the market.

But at this point, all eyes are turning toward the US payroll report. Here are the current forecasts:

Nonfarm Payrolls 175K
Private Payrolls 172K
Manufacturing Payrolls 18K
Unemployment Rate 4.1%
Participation Rate 62.7%
Average Hourly Earnings (AHE) 0.3% (2.6% Y/Y)
Average Weekly Hours 34.5
Michigan Sentiment 95.0

This report includes benchmark revisions so can get a bit messy sometimes, but forecasts for revisions to 2017’s data have been quite small, just 95K in the NFP data for the entire year.

So what can we expect? Arguably there are only three potential outcomes here; weak, strong or as expected. In the event the forecasts are on the money, I would look for the recent market trends to continue. That means equities will remain beholden to earnings, bonds will continue to fall, and the dollar will probably give up some of its overnight gains. This would play into the idea that the market pricing for the Fed is on the money and therefore the dollar would have further to decline.

How about a weak report? Well, weakness in NFP, or perhaps more importantly for the Fed in AHE, would cause some serious recalibrating throughout the market. In fact, if the data was weak enough, say 125K for NFP or 2.3% for AHE, it would likely be enough to halt the bond market decline in its tracks. This would be the type of data signal that would get the doves on the Fed crowing (cooing?) again and force the bond bears to rethink how aggressive the Fed will be this year. And the dollar? Ugh, it would not fare well in this case, likely giving up all its overnight gains and then some. In fact, I would expect a weak report to send the euro to new highs for the move, breeching the 1.2550 level and beyond before the end of the day.

Finally, what if the data is strong? NFP above 200K or a decline in the Unemployment rate to 4.0%, or even more interestingly for the Fed, AHE jumping to 2.9%, would play to the bond and stock bears and the dollar bulls. Remember, bond market momentum is already strongly toward a sell-off, and this would exacerbate that trend. At the same time, while US equity markets have spent the past two sessions little changed, equity markets around the world have been under consistent pressure alongside their bond markets. A strong report here and the ensuing bond market sell-off would likely undermine the stock market as well. As to the dollar, this would be nirvana. Positioning in the dollar is extremely short according to futures market indicators and those positions have been broadly profitable to date. However, strength in this report, especially with a new Fed chair coming in, will likely result in a bout of profit-taking at the very least, and I think we could see the dollar close the week far stronger than it started.

And that’s really it for the session. My sense is that strength is in our future and that we are going to see the bond market sell-off continue along with equity market declines and a stronger dollar. Will this be enough to change the trend by itself? Not likely. But it will be one more piece of evidence that the trend is going to change.

Good luck and good weekend