Not Really Dead

On Friday the rally in stocks
Resulted from word Goldilocks
Was not really dead
Because now the Fed
Would not need to sound like such hawks

After a great deal of new information last week, markets are opening this week in a far more subdued manner, arguably with far lower expectations. A quick look around shows that Asian equity markets followed Friday’s US market performance with strong rallies across the board while European markets are just edging higher. Bond markets, meanwhile, have shown resilience, although 10-year Treasury yields have drifted back to 2.90% as I type. And finally, FX markets have not displayed any coherent story this morning, with Friday’s dollar weakness in the wake of the payroll data largely maintained but not extended.

So let’s recap Friday’s data as I think it is important to help construct the narrative. By now we all know that the NFP number was killer at 313K, more than 100K higher than expected. But the real surprise came in the fact that the Participation Rate rose to 63.0%, up from 62.7%, while the Unemployment Rate remained unchanged at 4.1%. What this implies is that the economy has been growing strongly enough to draw people who were previously on the sidelines, and ostensibly not seeking jobs according to the BLS measurements, back into the workforce. This had been one of the key concerns of former Fed Chair Yellen, that there was ‘hidden’ unemployment and so the headline rate that had fallen to multi decade lows was overstating the tightness of the labor market. That Participation Rate had fallen steadily since the financial crisis and has been a source of concern. Part of it is demographic, as baby boomers retire and the workforce shrinks, but Friday’s data indicates that with the proper incentives, it is possible to ameliorate that decline. But just as important to the Goldilocks narrative was the fact that AHE data fell back to 2.6% from the 2.9% print last month. This implies that incipient wage pressures are not as strong as they seemed last month, and therefore the Fed need not be as aggressive as many had started to consider they would become. Hence, Goldilocks is back with strong growth and low inflation highlighting less need for the Fed to tighten rapidly.

In this context, Friday’s market reactions made perfect sense. On the equity side, continued low rates would support further economic and profit growth and hence continue to inflate the equity bubble allow for additional multiple expansion. Meanwhile, the assumed more dovish slant for the Fed would undermine the dollar further, thus opening the way for a continuation in its year-long decline. Adding to the dollar’s woes was the confirmation that the ECB would be removing its own accommodation by the end of this year, or at least would stop adding to it. And so, the Goldilocks narrative is alive and well for now. In fact, the only thing that I can see to derail it in the near term would be surprisingly higher inflation readings, high enough to have the central bank set appear to get nervous that they are falling behind the curve. Interestingly, this week brings the next set of CPI data from the US and Europe, so who knows, maybe it will happen.

Looking more closely at the FX market, there is no currency that has shown movement in excess of 0.3% overnight. In fact, in the G10 space, movement has been largely +/- 0.10%. Let me say that there is nothing of interest in that price action. Perhaps the only excitement was in Tokyo where a growing scandal about fnding of a controversial elementary school seems to have the potential to force Abe-san’s FinMin, Taro Aso, to resign. This would be a blow to Abe, as Aso has been one of his staunchest supporters in their attempt to reflate the Japanese economy. The market reaction has been a modest yen rally of 0.2%, I guess the idea being that they will not be able to be as aggressively easy in policy if Aso is forced out. In the EMG space movement has been just as desultory, with a spate of both winners and losers, but no stories and no large adjustments.

Turning to the data this week, it is not nearly as exciting as last week’s output, but we do see CPI on Tuesday and a range of other things that might adjust some thoughts. However, the Fed is in its quiet period ahead of their meeting a week from Wednesday, so no commentary is on the cards.

Today Budget Deficit -$216B
Tuesday NFIB Small Business Conf 107.1
  CPI 0.2% (2.2% Y/Y)
  -ex food & energy 0.2% (1.9% Y/Y)
Wednesday PPI 0.2%
  -ex food & energy 0.2%
  Retail Sales 0.4%
  -ex autos 0.4%
  Business Inventories 0.5%
Thursday Initial Claims 230K
  Philly Fed 23.3
  Empire Manufacturing 14.6
Friday Housing Starts 1.284M
  Building Permits 1.324M
  IP 0.3%
  Capacity Utilization 77.7%
  Michigan Sentiment 98.5

We also see Eurozone CPI on Friday, as well as important data from China during the week. But in the end, it feels like the narrative is back in control and we will need to have a series of data outcomes pointing to faster inflation in order to change that for now. The one place where things have a chance to get unsettled is in the Treasury auctions this week. As US budget deficits grow, so grows the amount of securities auctioned and there has been a distinct decline in the bid-to-cover ratios seen over the past several auctions. Quite frankly, while I don’t actually expect it to be the case, you cannot rule out the 10-year yield trading up to 3.0% in the event that investors are too busy buying stocks to bid for Treasuries. And 3.0% could turn a few heads. In the meantime, the narrative points to further dollar weakness, so I’m not going to fight that for now.

Good luck