Some Real Fed Appeasing

The jobs report Friday suggested
That everyone who has requested
Employment has found
That jobs still abound
And companies are still invested

The market response was less pleasing
At least for the bulls who seek easing
With equities falling
And yields, higher, crawling
Look, now, for some real Fed appeasing

We are clearly amidst a period of ‘good news is bad’ and ‘bad news is good’ within the market context these days. Friday was the latest evidence of this fact as the much better than expected Nonfarm Payroll report (224K vs. 160K expected) resulted in an immediate sell-off in equity and bond markets, with the dollar rallying sharply. The underlying thesis remains that weakness in the US (and global) economy will be sufficient to ensure easier monetary policy, but that the problems will not get so bad as to cause a recession. That’s a pretty fine line to toe for the central banks, and one where history shows they have a lousy record.

However, whether it is good or bad is irrelevant. What is abundantly clear is that this is the current situation. So, Friday saw all three major US indices fall from record highs; it saw 2-year Treasury yields back up 11bps and 10-year yields back up 8pbs; and it saw the dollar rally roughly 0.75%.

The question is, why were markets in those positions to begin with? On the equity side of the ledger, prices have been exclusively driven by expectations of Fed policy. Until the NFP report, not only was a 25bp rate cut priced into Fed funds for the FOMC meeting at the end of the month, but there was a growing probability of a 50bp rate cut. This situation is fraught with danger for equity investors although to date, the bulls have been rewarded. At least the bond story made more sense from a macroeconomic perspective, as broadly weaker economic data (Friday’s numbers excepted) had indicated that both the US and global economies were slowing with the obvious prescription being easier monetary policy. This had resulted in German bunds inverting relative to the -0.40% deposit rate at the ECB as well as US 10-year yields falling below 2.00% for the first time in several years. Therefore, stronger data would be expected to call that thesis into question, and a sell-off in bonds made sense.

And finally, for the dollar, the rally was also in sync with fundamentals as higher US yields, and more importantly, the prospect of less policy ease in the future, forced the dollar bears to re-evaluate their positions and unwind at least some portion. As I have been writing, under the assumption that the Fed does indeed ease policy, it makes sense that the dollar should decline somewhat. However, it is also very clear that the Fed will not be easing policy in a vacuum, but rather be leading a renewed bout of policy ease worldwide. And as the relative interest rate structure equalizes after all the central banks have finished their easing, the US will still likely be the most attractive investment destination, supporting the dollar, but also, dollar funding will still need to be found by non-US businesses and countries, adding to demand for the buck.

With this as a backdrop, the week ahead does not bring much in the way of data, really just CPI on Thursday, but it does bring us a great deal of Fed speak, including a Powell speech tomorrow and then his House and Senate testimony on Wednesday and Thursday. And don’t forget the ECB meeting on Thursday!

Today Consumer Credit $17.0B
Tuesday NFIB Small Biz 105
  JOLT’s Jobs Report 7.47M
Wednesday FOMC Minutes  
Thursday ECB Meeting -0.4%
  Initial Claims 222K
  CPI 0.0% (1.6% Y/Y)
  -ex food & energy 0.2% (2.0% Y/Y)
Friday PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Remember, that on top of the FOMC Minutes to be released Wednesday afternoon, we will hear from seven different Fed speakers a total of thirteen times this week, including Powell’s testimony on Capitol Hill. Amongst this crowd will be the two most dovish members of the FOMC, Bullard and Kashkari, as well as key members Williams and Quarles. It will be extremely interesting to see how these speakers spin the jobs data relative to their seemingly growing bias toward easing. Much has been made of the idea of an ‘insurance’ rate cut, in order to prevent anything from getting out of hand. But Powell will also need to deal with the allegations that he is capitulating to President Trump’s constant demands for lower interest rates and more QE if he comes across as dovish. I don’t envy him the task.

Regarding the ECB meeting, despite continuing weakness in most of the Eurozone data, it feels like it is a bit too soon for them to ease policy quite yet. First off, they have the issue of what type of impact pushing rates even further negative will have on the banking system there. With the weekend news about Deutsche bank retrenching across numerous products, with no end of red ink in sight, the last thing Signor Draghi wants is to have to address a failing major bank. But it is also becoming clearer, based on comments from other ECB members (Coeure and Villeroy being the latest) that a cut is coming soon. And don’t rule out further QE. The ECB is fast becoming desperate, with no good options in sight. Ultimately, this also plays into my belief that despite strong rationales for the dollar to decline, it is the euro that will suffer most.

However, the fun doesn’t really start until tomorrow, when Chairman Powell speaks at 8:45am. So for today, it appears that markets will consolidate Friday’s moves with limited volatility, but depending on just how dovish Powell sounds, we are in for a more active week overall.

Good luck
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