Tuesday's trading (August 6, 2013) brought out the taper tantrum jitters again. Officials from the Federal Reserve are once again reminding financial markets about the potential for September to bring the beginning of the end of QE3′s bond-buying program. In recent days both Charles Evans, the president of the Chicago Federal Reserve, and Richard Fisher, the president of the Dallas Federal Reserve, looked at Friday's jobs report and declared some victory for the economy.
Fisher reminded the market of his well-known hawkishness relative to QE3 and used Friday's reported drop in the unemployment rate to 7.4% to underline the point. Evans was not quite as bullish, but he did proclaim a growth spurt for the economy (2.5% annualized growth for U.S. GDP) in the second half which would certainly provide the necessary justification for ending QE3′s bond purchases. Evans was commonly cited in the media as a reason for the S&P 500 (NYSEARCA:SPY) losing a little altitude to the tune of -0.6% even though he did not pin down September as a specific deadline.
The end result is that the market is now slowly but surely reversing the nice breakout that began the month.
On the other side of these Fed officials sit pundits who insist that Friday's jobs report was a disappointment. The main sticking point was another small drop in the labor participation rate. The fractional drop to 63.4% explained much of the reduction in the unemployment rate, and it was enough to motivate one Reuters writer to claim that the Fed now has plenty of room to remain accomodative.
On Yahoo Finance's the Daily Ticker, Dan Alpert, managing partner at Westwood Capital, claimed that the jobs report provided more evidence that U.S. job-creation has been overly concentrated in low-wage sectors. Alpert calculates that the difference between working in these low-wage jobs and being on government assistance provides little to no extra consumption power for the economy. He concludes:
What you're seeing is now the spreading of low wage growth…Really we have become a nation of hamburger flippers, Wal-Mart sales associates, barmaids, checkout people and other people working at very low wages.
The ability to interpret the data as both bullish and bearish has created some odd, even confused(?) patterns in financial markets. When I wrote "An Uneven Recovery From The Interest Rate Blues" three weeks ago, the S&P 500 had completed a full recovery from the jitters created by soaring interest rates. Other sectors were not so lucky. Now, it seems the bond market simply has a mind of its own and/or the rest of the market has chosen to ignore the steady climb in rates.
The chart below shows the iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) on a steady downtrend since early May (higher interest rates) (bright green line). Surrounding TLT is an odd mixture of reactions and even anticipations.
A mixed collection of partners that are supposed to be impacted by higher interest rates
First, there is gold (NYSEARCA:GLD) which had its biggest panic moment without a spike in rates or a spike higher in the U.S. dollar (see the orange line). Gold has proceeded to trend downward such that it now looks like higher rates are weighing on its price. The S&P 500 continued to rally through May (as expected), and when it finally corrected a bit, it seemed that interest rates were a large culprit. Now, rates are higher AND the S&P 500 is higher (blue line). The iShares Dow Jones US Home Construction (NYSEARCA:ITB) is now flat for the year (brown line). It is certainly underperforming the S&P 500, but it is hard to say that homebuilders are getting directly hit by higher rates. Perhaps ITB would still be following the S&P 500 higher if it were not for higher rates. It is hard to tell. I sure would have expected a much larger move downward. Finally, the U.S. dollar index (NYSEARCA:UUP) has bounced within a tight trading range (dark green line) - not helped by higher rates and not helped by the bullish talk from Federal Reserve chatter.
It was tempting for me to conclude that perhaps the missing element is inflation expectations. If inflation expectations are increasing along with rates, then real rates are not changing. However, stationary real rates cannot consistently explain this mix of movements in the financial market. Moreover, the estimates for inflation expectations from the Cleveland Federal Reserve continue to show a steady decline even as nominal rates have risen.
I am left with the conclusion that the bond market is essentially following a mind of its own while only some elements of the market choose to care. Dan Alpert projects that once the September tripwire comes and goes, the market will relax and rates will begin to fall again to reflect the weakness in the job market. If he is correct, then it is certainly possible some market participants are choosing to look ahead to a cooling of rates even as others are fretting about extrapolations of higher rates. (Of course, expectations of continued weakness in the labor market would make the strong rally in stocks even more of a puzzle). This is all likely a recipe for increasing volatility in the coming month although one might not realize it looking upon examining the volatility index. The VIX is scraping at 6+ year lows again.
The VIX continues to sag
Source for charts: FreeStockCharts.com
I like to track the percentage of stocks trading above their 40-day moving averages. This indicator has limped lower for two weeks after stopping "inches" short of hitting the overbought level (70%). It fell to 56.2% on Tuesday which, in combination with slowing momentum in the S&P 500, I assume to mean that higher rates in the bond market and the looming September deadline, are finally starting to weigh on the market again. I think such a correction will be just as buyable as the one that ended in oversold conditions in late June (the percentage of stocks trading above their 40-day moving averages fell below 20%). The path to that buying point should be even more disconcerting than the last one given the mixed signals swirling around the bond market right now. Currency markets will likely amplify the churn.
Be careful out there!
Disclosure: I am long TBT, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In forex, I am net long the U.S. dollar (mainly against the euro and yen).