Tag Archives: #AHE

Still Under Stress

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As traders are forced to assess
A bond market still under stress
Today’s jobs report
Might be of the sort
That causes some further regress

Global bond markets are still reeling after the past several sessions have seen yields explode higher. The proximate cause seems to have been the much stronger data released Wednesday in the US, where the ADP Employment and ISM Non-Manufacturing reports were stellar. Adding to the mix were comments by Fed Chairman Powell that continue to sing the praises of the US economy, and giving every indication that the Fed was going to continue to raise rates steadily for the next year. In fact, the Fed funds futures market finally got the message and has now priced in about 60bps of rate hikes for next year, on top of the 25bps more for this year. So in the past few sessions, that market has added essentially one full hike into their calculations. It can be no surprise that bond markets sold off, or that what started in the US led to a global impact. After all, despite efforts by some pundits to declare that the ECB was the critical global central bank as they continue their QE process, the reality is that the Fed remains top of the heap, and what they do will impact everybody else around the world.

Which of course brings us to this morning’s jobs data. Despite the strong data on Wednesday, there has been no meaningful change in the current analyst expectations, which are as follows:

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 12K
Unemployment Rate 3.8%
Participation Rate 62.7%
Average Hourly Earnings (AHE) 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.5B

The market risk appears to be that the release will show better than expected numbers today, which would encourage further selling in Treasuries and continuation of the cycle that has driven markets this week. What is becoming abundantly clear is that the Treasury market has become the pre-eminent driver of global markets for now. Based on the data we have seen lately, there is no reason to suspect that today’s releases will be weak. In fact, I suspect that we are going to see much better than expected numbers, with a chance for AHE to touch 3.0%. Any outcome like that should be met with another sharp decline in Treasuries as well as equities, while the dollar finds further support.

Away from the payroll data, there have been other noteworthy things ongoing around the world, so lets touch on a few here. First, there is growing optimism that with the Tory Party conference now past, and PM May still in control, that now a Brexit deal will be hashed out. One thing that speaks to this possibility is the recent recognition by Brussels that the $125 trillion worth of derivatives contracts that are cleared in London might become a problem if there is no Brexit deal, with payment issues needing to be sorted, and have a quite deleterious impact on all EU economies. As I have maintained, a fudge deal was always the most likely outcome, but it is by no means certain. However, today the market is feeling better about things and the pound has responded by rallying more than a penny. The idea is that with a deal in place, the BOE will have the leeway to continue raising rates thus supporting the pound.

Meanwhile, stronger than expected German Factory orders have helped the euro recoup some of its recent losses with a 0.25% gain since yesterday’s close. But the G10 has not been all rosy as the commodity bloc (AUD, NZD and CAD) are all weaker this morning by roughly 0.4%. Other currencies under stress include INR (-0.6%) after the RBI failed to raise interest rates as expected, although they explained there would be “calibrated tightening” going forward. I assume that means slow and steady, but sounds better. We have also seen further pressure on RUB (-1.3%) as revelations about Russian hacking efforts draw increased scrutiny and the idea of yet more sanctions on the Russian economy make the rounds. ZAR (-0.75%) and TRY (-2.0%) remain under pressure, as do IDR (-0.7%) and TWD (-0.5%), all of which are suffering from a combination of broad dollar strength and domestic issues, notably weak financial situations and current account deficits. However, there is one currency that has been on a roll lately, other than the dollar, and that is BRL, which is higher by 3.4% in the past week and 8.0% since the middle of September. This story is all about the presidential election there, where vast uncertainty has slowly morphed into a compelling lead for Jair Bolsonaro, a right-wing firebrand who is attacking the pervasive corruption in the country, and also has University of Chicago trained economists as his financial advisors. The market sees his election as the best hope for market-friendly policies going forward.

But for today, it is all about payrolls. Based on what we have heard from Chairman Powell lately, there is no reason to believe that the Fed is going to adjust its policy trajectory any time soon, and if they do, it is likely only because they need to move tighter, faster. Today’s data could be a step in that direction. All of this points to continued strength in the dollar.

Good luck and good weekend
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Soared Like a Jet

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On Friday the jobs report showed
More money, to more people flowed
Earnings per hour
Has gained firepower
So interest rate hikes won’t be slowed

The market response, though, was bleak
With equity prices quite weak
However the buck
Had much better luck
And soared like a jet, so to speak

As the week begins, we have seen the dollar cede some of the gains it made in Friday’s session. That move was a direct result of the payroll data, where not only did NFP beat expectations at 201K, but the Average Hourly Earnings number printed at 0.4% for the month and 2.9% annualized. That result was the fastest pace of wage growth since 2009 and significantly higher than the market anticipated. It should be no surprise that the market response was higher interest rates and a concurrently stronger dollar. Overall, the dollar was higher by a solid 0.5% and 10-year Treasury yields jumped 5bps on the day.

Wage growth has been the key missing ingredient from the economic data for the past several years as economists continue to try to figure out why record low unemployment has not been able to drive wages higher. The Fed reaction function has always been predicated on the idea that once unemployment declines past NAIRU (Non-accelerating inflation rate of unemployment), more frequently known as the natural rate of unemployment, that wages will rise based on increased demand for a shrinking supply of workers. Yet the Fed’s models have been unable to explain the situation this cycle, where unemployment has fallen to 50 year lows without the expected wage inflation. And of course, the one thing every politician wants (and Fed members are clearly politicians regardless of what they say) is for the population to make more money. So, if Friday’s data is an indication that wage growth is finally starting to pick up, it will encourage Powell and friends to continue hiking rates.

This was made clear on Friday by Boston Fed President Eric Rosengren, who had been a reliable dovish voice for a long time, when he explained to the WSJ that the Fed’s current pace of quarterly rate hikes was clearly appropriate and that there need to be at least four more before they start to consider any policy changes. There was no discussion of inverting the yield curve, nor did he speak about the trade situation. It should not be surprising that the Fed Funds futures market responded by bidding up the probability of a December rate hike to 81% with the September hike already a virtual certainty.

But that was then and this is now. This morning has seen a much less exciting session with the dollar edging slightly lower overall, although still showing strength against its emerging market counterparts. Looking at the G10, the picture is mixed, with the euro and pound both firmer by 0.15% or so. The former looks to be a trading response to Friday’s decline, while the latter is benefitting, ever so slightly, from better than expected GDP data with July’s print at 0.3% and the 3-month rate at 0.6%. We’ve also seen AUD rally 0.25%, as firmer commodity prices seem to be underpinning the currency today. However, both CHF and JPY are softer this morning, with the Swiss franc the weakest of the bunch, down 0.65%.

In the EMG space, however, the picture is quite different, with INR making yet another new historic low as the market continues to respond to Friday’s worse than expected current account deficit. The rupee has fallen a further 0.85% on the day. We’ve also seen weakness in CNY (-0.25%), RUB (-0.45%) and MXN (-0.2%). But some of the biggest decliners of recent vintage, TRY and ZAR, have rebounded from their worst levels, although they are still off significantly this year.

Looking ahead to this week, the data is fairly light with just CPI and Retail Sales in the back half of the week, although we also get the Fed’s Beige Book on Wednesday.

Tuesday NFIB Business Optimism 108.2
  JOLT’s Job Openings 6.68M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.8% Y/Y)
  Beige Book  
Thursday Initial Claims 210K
  CPI 0.3% (2.8% (Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Retail Sales 0.4%
  -ex autos 0.5%
  IP 0.3%
  Capacity Utilization 78.4%
  Michigan Sentiment 96.9

There are also a number of Fed speakers this week, but I have to say that it seems increasingly unlikely that there will be any new views coming from them. The doves have already made their case, and the hawks continue to be in the ascendancy.

Net, I see no reason to believe that anything in the market has really changed for now. Rate expectations remain for higher US rates, and growth elsewhere continues to be okay but not great. Ultimately, things still point to a higher dollar in my view. Not forever, but for now.

Good luck
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Lighthearted

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At this point one must be impressed
Investors have not become stressed
A trade war has started
Yet they are lighthearted
With willingness still to invest

On top of that word from the Fed
Is they will keep pushing ahead
With rate hikes until
Our growth starts to chill
Or when markets start to bleed red

There has certainly been a lot to digest in the past twenty-four hours. Arguably the biggest story is the imposition of tariffs by the US on $34 billion worth of Chinese goods, which began at midnight last night. China is responding in kind and the Trump administration is determining whether they want to up the ante by an additional $200 billion. Now that the trade war is ‘officially’ underway, the key questions are just how far it will go and how long it will last. While there has been nothing in the press indicating that background negotiations are ongoing and that things can be resolved soon, based on the US equity market’s insouciance, it certainly seems that many investors feel that is the case. I hope they are correct, and soon, because otherwise I expect that we will see a more substantial correction in stocks. As to the dollar in this case, I expect that it will continue to benefit from its safe haven status in a time of market turmoil.

A second fear for equity investors has to be the Fed, which explained in yesterday’s release of the June meeting minutes, that while the trade situation could well become a concern in the future, for now they are much more focused on the potential for the US economy to overheat. The upshot is that the Fed is bound and determined to continue normalizing policy by gradually raising rates and by allowing the balance sheet to continue to gradually shrink. Speaking of the balance sheet, starting this month, they are going to allow $40 billion per month to roll off, and then beginning in October, it will be $50 billion per month until they reach whatever size they determine is appropriate. That means that $270 billion of bids for Treasury’s are going missing for the rest of the year. As the Fed continues to drain liquidity from the economy, I expect that the dollar will continue to benefit across the board, and that the US equity market will face additional headwinds. After all, QE was effective in its goal of forcing investors further out the risk curve and driving equity prices around the world higher as central banks everywhere hoovered up government bonds. Well, with yields rising and central banks backing away from the market (all while equity prices remain robustly valued) it seems there is ample opportunity for a substantial correction in stocks.

You may have noticed I said exactly the same thing when discussing the trade war situation. My point is that we are starting to see multiple catalysts align for a potential change in tone. A higher dollar and lower US (and likely global) equity prices seem like an increasingly possible outcome. Be prepared.

This leaves us at our third big story for the day, the payroll report this morning. Yesterday’s ADP Employment number was a mild disappointment, rising 177K rather than the 190K expected, but the reason appeared to be a lack of available workers rather than a lack of demand for hiring. In other words, the labor market in the US remains extremely strong. Or so it seems. Here are this morning’s expectations:

Nonfarm Payrolls 195K
Private Payrolls 190K
Manufacturing Payrolls 18K
Unemployment Rate 3.8%
Average Hourly Earnings 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$43.7B

It strikes me that this is a potential third catalyst that will line up with the trade war and Fed story in that a strong print today will encourage the Fed to continue or even accelerate their activities; it will encourage the administration that they can outlast the Chinese in this war of attrition, and so the dollar is likely to firm up while equity markets suffer. In the event payrolls disappoint, I think we could see the dollar’s modest correction lower continue and I expect that equity markets will be fine, at least in the US.

Remarkably, I don’t have space to more fully discuss what appears to be a euro positive, where Chancellor Merkel has averted disaster in Germany by getting the third coalition partner, the SPD, to agree to her immigration reforms thus keeping her government intact. As long as this internal truce lasts, there should be no further impact on the euro, but if the problem arises again (and I’m pretty sure it will soon) the euro is likely to suffer. At the same time, the pound is on tenterhooks as PM May is meeting with her cabinet today to finalize a negotiating stance regarding Brexit. If she cannot get the cabinet to agree, I expect the pound will feel the heat as concern over the fall of the May government will rise and an election campaign just nine months before the deadline for leaving the EU cannot be seen as a positive, especially with the chance that Jeremy Corbyn, the far-left Labour Party leader could become the next PM. Investors will not appreciate him in that seat, at least not at first.

As to the overnight session, the dollar is slightly softer and equity markets are under modest pressure, including US futures, as the market awaits the labor situation report. Remember, too, that many trading desks remain lightly staffed because of the holiday, and so liquidity is going to be a bit less robust than normal. If pressed my thought is that NFP will print near consensus, around 200K. I just wonder if the Unemployment Rate doesn’t tick even lower. And keep an eye on AHE, where my gut tells me it will be 0.4% enough to get Fed tongues wagging again. Net, I like the dollar to end the week on a strong note.

Good luck and good weekend
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