A Great Hullabaloo

Investors collectively squealed
When tariffs, by Trump, were revealed
That opening tactic
Proved anticlimactic
When ongoing talks were revealed

Then last night from out of the blue
Amid a great hullabaloo
The Prez indicated
That he was frustrated
Thus more tariffs now will debut

Meanwhile a few hours from now
The employment report takes its bow
The critical gauge is
The hourly wages
Where strength could give Powell a cow

Just when you thought it was safe to go back in the water…

Let’s consider the recent timeline for a moment:

Tuesday night – Trump imposes tariffs on $50 billion of Chinese goods, the Chinese immediately respond and equity prices collapse around the world
Wednesday mid-day – Wilbur Ross and Larry Kudlow explain that senior level negotiations are ongoing between the US and China and that no trade war is imminent. Stock prices immediately turn around, rallying sharply around the world as FOMO grips the investor community
Thursday night – after a two day global equity rally, President Trump surprises one and all by announcing an additional $100 billion in tariffs on Chinese goods with China responding immediately and saying, “The Chinese side will follow suit to the end, not hesitate to pay any price, resolutely counterattack and take new comprehensive measures in response.” I don’t know about you, but when the Chinese invoke the specter of Winston Churchill, it sounds pretty warlike to me!

It should be no surprise that risk has been jettisoned yet again after this latest round of commentary with equity markets in Asia and Europe both falling while US equity futures are pointing lower. Interestingly, the dollar, which has been performing quite well lately, is little changed this morning, as are Treasuries and gold, neither of which seems to be benefitting from a flight to safety. My take is that investors are simply confused at this point and don’t really know which way to turn. And in fairness, how can you know what to expect at this point? The one constant of the Trump administration for market participants is that there is no surety as to what will happen.

So since I have no idea what will occur with the trade situation (does anybody?), I guess its time to focus on the payroll report. Current expectations are as follows:

Nonfarm Payrolls 175K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 4.0%
Participation Rate 62.8%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5

The clues that we have seen lately seem to point to another strong report. ADP Employment was a much stronger than expected 241K. The ISM data showed both firmer employment sub-indices as well as firmer price indices, implying that wages remain robust. And of course, Core PCE was firmer than expected last week, adding to the idea that price pressures are increasing. Anecdotally we have seen teachers around the country going on strike for pay raises, and getting them, with the smallest increase I have seen being 5.0%. That certainly smacks of wage inflation and by all accounts, that is the thing the Fed is most focused on. It is hard for me to look at the evidence without getting the feeling that any data surprise will be on the high side.

The question, of course, is how will the market respond to a surprise of any sort. Inflation remains the key driver of policy decisions at this point. In fact, if the Unemployment rate does fall to 4.0%, it will only add further angst to the FOMC as they watch it decline further below NAIRU and given their ongoing belief in the Phillips Curve, prepare for even more inflation. So I continue to believe the AHE number is the most important part of the report. I’m sure you all remember what happened in the February release when AHE jumped to 2.9% and equity markets subsequently fell 10% in a few days. Quite frankly, I don’t rule out a repeat of that type of performance. After all, it is clear that the Fed is geared up to continue raising rates. It has also become clear that Chairman Powell, unlike his three predecessors, is quite comfortable watching equity market volatility rise amid uncertainty and a declining stock market. Finally, it also appears that the FOMC is very keen to ‘normalize’ monetary policy, which I take to mean Fed Funds back at long-term levels of 3% – 4% alongside a much smaller balance sheet. I assure you, another 2.9% print will encourage all of that behavior. In fact, I would argue it will cement four rate hikes for this year. In that event, I like the dollar to continue its recent modest strength, I think equities will suffer, and I expect Treasuries will be caught between concerns over higher inflation driving rates higher and flight to safety driving them lower, so likely not move much at all.

On the other hand, a weak print today will be unambiguous across markets. Equities will recoup their trade war induced losses (unless the rhetoric increases), the dollar will suffer immediately and Treasuries will simply rally, with yields probably falling back to the bottom of the recent trading range. We shall see.

One other thing to note about today, Chairman Powell speaks about the economic outlook at 1:30 this afternoon. Given his penchant for straight talk, I expect that we will have a very good idea about how his thoughts have evolved since the March FOMC meeting. So its not just trade and payrolls today, but Powell as well. I would err on the side of being long dollars here, as the evidence points to both solid payroll gains and higher wages.

Good luck