Key Questions Unanswered About Reality of US Jobs Picture, Key Market Movers This Week Will Help Answer Them. Part 1 of 2 part series. To help prepare investors and traders in most globally traded assets for the coming market week
This article focuses mostly on US developments affecting all global assets. Stay tuned for Part 2, due out in the coming 24 hours, to cover the state of the current global market rally and pullback, as well as lessons and likely market movers to watch this week from around the world.
Key Question For Fed And Markets: Is Unemployment Actually Much Higher Or Lower?
In a Monday article in the Wall Street Journal, Jon Hilsenrath wrote about the biggest open question facing Fed policy at the moment: just how much slack in the labor market is there? "The trend raises hard-to-answer questions for the Fed," says Hilsenrath of the recent drop in labor force participation. "Will some of these people come back to work when the economy improves or have they left permanently? Do these shifts mean there is less slack in labor markets - workers available to take jobs - than they realized, or is the slack still out there, hidden in these numbers?" (via businessinsider.com premarket commentary Monday).
Why This Matters: Wage Inflation Threatens To Spark General Inflation
The question is a big deal because the Fed is basing much of its decisions about the pace of stimulus reduction based on its understanding of the labor situation. If in fact real unemployment is much higher, then the Fed would be biased to more dovish policy and a slower or even halted taper. If however there aren't as many unemployed seeking work as previously believed, then the taper could be accelerated as it's likely to do more harm (potential inflation, financial suppression hurting savers, pension funds, etc.) than good (encouraging job creation) because not as many new jobs are needed and if labor demand rises too fast due to stimulus, we'd risk wages rising too quickly for the economy to easily adapt, and thus risk an inflation spike.
Glushkin Sheff's David Rosenberg expressed concern about how the minor GDP growth was causing such a radical drop in unemployment over the past year in his testimony to the U.S. Senate Budget Committee earlier this week. He noted that such rapid drops in unemployment were rare and only occurred in times of much higher GDP, suggesting that there's a shallower pool of unemployed than previously thought. He questioned whether there was a real lack of workers, or just too many who chose not to work due to excessive government benefits programs that encouraged those fit to work to continue taking government handouts.
Rosenberg had warned us about wage inflation pressures just a few weeks ago.
Remember, we're still in an age of unprecedented QE, so it's still unclear whether the Fed could in fact drain excess cash out of the financial system quickly enough (or even realize the need to do so) if wages, and thus demand for goods and services, suddenly spike higher.
Contrary to what many believe, the Fed has no crystal ball, nor even especially reliable models for modeling the US economy. Not surprisingly, its track record of anticipating changes in the economy is, ahem, not reassuring.
US Mfg Slowdown Monday
On Monday the ISM manufacturing index plunged to 51.3 in January versus 56.5 in December and an expected 56.0. The new orders sub-index power-dived to 51.2 from 64.4. There was debate over whether this, like the prior jobs reports, was mostly due to bad weather.
Despite the EMs' turmoil and their weakened currencies, the export orders index didn't weaken too much. It dropped from a multi-year high of 59.5 in November to 55.0 in December and 54.5 in January, but was still well above last year's low of 51.0 in May or the series of sub- 50 readings (contraction) during the global trade weakening in 2012.
Here's an odd discrepancy worth noting - the ISM index, which is based on a national survey, looked worse than all of the major regional surveys.
As noted in our earlier article for this week, Global Markets Weekly 2 Minute Drill: Daily Recap & Market Movers: Calming Despite Data, the US wasn't alone - China had also just printed weaker manufacturing data.
Why Stocks Shrugged off The Weak Jobs Report And Other Ramifications
US and European stocks rose Friday despite the weaker than expected jobs report, deeming it as bad but not at all disastrous. After all, the US is continuing to add jobs and recover, though perhaps at a slower pace. That in itself sends two supportive messages to stocks and other risk asset investors.
• First, the US is continuing to grow and recover, even if at a slower than expected pace.
• Second, the slowing job growth lowers the chances that the Fed might accelerate the taper
Additionally, there were some bright spots to counteract the weak job growth figure (1132 vs 180k expected).
• The unemployment rate unexpectedly fell to 6.6% from 6.7%, even as more Americans enter the workforce, thus boosting the labor force participation rate to 63.0% from 62.8%.
• The report also showed increased employment in construction, and a decline in government work.
• Here's Morgan Stanley's Ted Wieseman in one sentence: "There was a dramatic contrast between the sluggish establishment (NYSE:NFP) survey and a very strong household (unemployment rate) survey that creates some uncertainty."
• Arguably sentiment is getting some support from earnings results, which show S&P 500 companies are on track to print average EPS gains of 9%-10%.
Other positives included:
1. The unemployment rate continued to drop - it unexpectedly fell to 6.6% from 6.7%, even as more Americans enter the workforce, thus boosting the labor force participation rate to 63.0% from 62.8%.
2. Average hourly earnings and the labor force participation rate increased.
3. The monthly payrolls report can be volatile anyway
4. Jobs growth, and the recovery, are still continuing. During the past 6 months, the U.S. is still adding 177,500 jobs per month on average.
5. Of equal importance, the report meant that the US has growth AND a lower chance that the Fed might accelerate the taper. The current rate of taper is priced in, however acceleration is not, and any such surprise could pressure risk assets and boost the USD.
6. The 0.2% increase in average hourly earnings and the labor force participation rate suggests that jobs are paying better and that encourages people to return to the worker force. That explains how the broader and more reliable U6 unemployment rate also dropped from 13.1% to 12.7%, its lowest level since November 2008.
7. Arguably sentiment is getting some support from earnings results, which show S&P 500 companies are on track to print average EPS gains of 9%-10%.
Given the above, it's no surprise that on Friday stocks were up and the USD was down. The jobs report signaled:
· Growth without faster taper: bullish for risk assets.
· Less chance of the two things most likely to lift the USD:
o A deeper market selloff that increases the USD's appeal as a safe-haven
o The odds of a faster taper, which raises the USD's appeal as a less diluted currency with higher interest rates coming sooner than expected
In sum, markets got the bullish message of continued gradual recovery without the bearish increasing of odds of the FOMC announcing an accelerated taper. Instead, due to weaker job growth, the Fed is now more likely to amend its forward guidance as the unemployment rate has long passed the 7% rate that was supposed to signal the end of QE, and it now approaches their 6.5% threshold for accelerating the taper AND for discussing the pace and timing of actual interest rate hikes.
Given the recent selloffs in risk assets, and their nascent rally Thursday and Friday, it seems that investors are still inclined to see the past weeks' selloff as more of a buy the dip opportunity than a start of a more prolonged pullback, despite the technical damage to the leading global stock indexes shown above.
Thus Janet Yellen's first decision at the helm of the FOMC (arguably the most powerful unelected body in the democratic world - you go girl!) will be to decide whether to lower the threshold, downgrade its importance, or drop it completely like Fed President Lacker had proposed earlier this week, saying that the Fed "will have to reformulate and provide some qualitative way of providing an assessment of what time horizon we think is most likely" for rates to start rising. Translation: "we need to make clear that we're not tightening yet, so everybody stay calm."
What will the Fed do? Funny you should ask.
Top Market Movers This Week From The Economic Calendar Yellen Testimony: Latest Clues On Fed Outlook, Policy
This week Yellen gives her very first semi-annual testimony on the economy and monetary policy. Along with retail sales, it could be the biggest market mover on the US calendar. Which is more influential depends on which provides a bigger surprise.
Here's what you need to know about what could be the biggest market moving event of this week.
Our first chance to hear Yellen's interpretation of the data and here response to it is this week, when she gives her very first semi-annual testimony on the economy and monetary policy.
She testifies before the House on Tuesday and Senate on Thursday. Her prepared remarks will be released 8:30am EST Tuesday, 90 minutes before she delivers her first policy address on the economy as Federal Reserve Chairman.
She'll be asked about what the Fed plans to do with their 6.5% unemployment rate threshold and most likely she'll answer that the FOMC will reevaluate the forward guidance in March.
As always, retail sales could also be a big market mover, given the ~70% of GDP that consumer spending comprises. It is expected to remain at only 0.2%, the same as in the previous month. A strong reading would usually be bullish for risk appetite and thus the pair, but now the likely market reaction is less certain. If markets interpret the result as they did the jobs reports - growth without higher risk of accelerated taper - that would be bullish for the EURUSD. An opposite interpretation would be bearish for it.
Other Key Calendar Events
China Data Dump: Trade balance is the big one. There's also money supply, and new loans. Remember for all the blame placed on the Fed taper as a source of emerging market volatility, that China's slowdown and policy moves, have been disruptive for EMs. Bullish results are bullish for the pair.
In addition to the above mentioned retail sales and Yellen testimony, there's weekly unemployment claims, which could be market moving only if it produces a major surprise.
The Italian 10 year bond auction might be market moving, but only if there's a very surprising result. Markets will be watching to see if it suggests continued appetite for EU periphery bonds
China: YOY CPI and PPI - given ongoing concerns about rates and liquidity, if this influences overall risk appetite it could move the EURUSD .
EU: There's French, German, Italian preliminary GDP, and EU flash GDP. These could be market moving if they show a consistently positive (bullish for the EURUSD) or negative result (bearish for it)
US: Preliminary UoM consumer sentiment might matter if it sends a starkly different message than the actual retail sales data from Thursday.
Stay Tuned For Part 2
The second part can be found here, and will cover whether the current pullback is just temporary or the start of a bigger correction ahead, as well as likely market movers from the rest of the world for this week and beyond.
Curious about what's driving the US dollar? Want a quick summary of the prior week's day-by day action in global markets and the market movers driving them? See here.
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For Part 2 go here
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.