Tomorrow's payrolls have a chance of halting the dollar slide

Outlook

Everyone or nearly everyone thinks we now have Free Money Forever (FMF) and thus ever-rising equities--without considering that the root causes of this situation are extremely unfavorable. One thing pops up (employment, say) but another flops down (global conditions). We have no idea whether to trust the five Fed hawks (yes, we need a rate hike) or the Fed chief (there are solid reasons to be cautious).

In fact, we say central banks are not actually doing a very good job if experienced Fed-watchers are so befuddled. And as for negative rates, the Market News fixed income analyst is reaching the end of her rope: “People have got to stop pretending negative rates are a good thing. Instead of pushing the central bankers to save the world with empty tool chests, why don't people put the heat on the politicians and world leaders to solve the structural and fiscal issues that are clearly holding back the world's economies?”

The analyst points out something that boggles the mind--Ireland sold a 100-year bond at a yield of 2.35%. Ireland is rated A+ (S&P) or A (Fitch) for long-term paper. Okay, it was small, only €114 million, and a private placement, but 2.35% is lower than the US 30-year at 2.66% (where the S&P rating is AA+). For a hundred years! And not so long ago, the yield was flirting with 10%. Trading economics says the Irish 10-year reached a record high of 14.76 in January of 1985 and a record low of 0.65 in April of 2015. In between, in December 2010, Moody’s shocked with a downgrade by five whole notches to BAA1, with a negative outlook, because of the bank crisis. Moody's had previously rated Ireland as AA2 – the third highest level. This 5-notch downgrade left Ireland’s sovereign credit rating just three places above "junk.”

One bond guy told the Market News analyst "the only way investors get a single basis point of positive real return is if Europe has 4 generations of economic stagnation."

Things are hardly much better in the US. See the chart of the Reuters 10-year yield index. It’s the weekly version. The yield has shifted from a high of 3.036% in January 2014 to a lowest low of 1.567% in February this year. Wait a minute. During this time the economy was recovering, not failing. This chart shows no recognition of organic economic growth. If you saw this chart and didn’t know what country it came from, you’d think the country had exceptionally low growth and low or falling inflation.

You can argue that in some months over the past two years, those would be a good description of the US. But mostly, overall, it’s not accurate. Technically, the NBER called the end of the recession in June 2009—almost seven years ago. This yield chart indicates the bond boys don’t buy it for a minute. They think the recession is still in place.

BoE Gov Carney, speaking at a Financial Stability Board conference in Japan, said low growth problems can’t be solved by monetary policy alone. "There is a clear recognition that the challenges of a low nominal growth environment will not be solved by monetary policy alone and that developments over the course of the past several years globally are serving to reinforce those realities." According to Reuters, Carney “warned that if a low nominal-growth environment persists for years, it could undo some of the efforts made by policymakers and banks in rebuilding a sustaining and resilient financial system. ‘In the end, if you don't have profitable financial institutions then gradually that resilience is undercut. The core lessons of this doesn't go to monetary policy or financial stability policy. But it does go to structural policies needed to enhance productivity alongside efforts to reflate our economies.”

We had to go look up the Financial Stability Board, so far not a big-name player (nor likely to become one). Everybody and his brothers belongs to it, from the G7 countries to the IMF, Basel, the Saudis and a slew of other members. The website says “The Plenary is the sole decision-making body of the FSB. It consists of representatives of all Members and is currently composed of 54 representatives from 25 jurisdictions, six representatives from four international financial institutions and nine representatives from six international standard-setting, regulatory, supervisory and central bank bodies.” Well, that’s the committee that is designing a horse and getting a camel.

The secret solution to the problem of endless stagnation keeps rearing its head—labor productivity. The latest contribution to this discussion is from the WSJ’s Ip, who is an obnoxious twit but a pretty good reporter. He writes “… productivity growth is zero in developed economies and negative in emerging countries. If global productivity had grown at the 1.7% pace that prevailed from 2003 to 2007, global growth would now be 4.2% instead of 2.4%, the bank (IMF] estimates. Mr. Obama’s economists reckon that if U.S. productivity had grown at its historical trend, then last year’s drop in unemployment would have produced GDP growth of 4.3% instead of 2%.

“Weak demand may have held back productivity as companies in the aftermath of recession and financial crisis were reluctant to invest in efficiency-enhancing equipment. And companies may be substituting labor for capital because wages are so low.

“But the fact that productivity began slowing before the crisis and has done so in countries that largely dodged recession suggests that underlying causes are structural: the shift in many countries to low-productivity services from high-productivity manufacturing; the waning payoff from technology innovation; and slower growth in human capital, such as education.

“The fact that so much of the weakness in growth is due to productivity (which helps explain depressed wage growth) and demographics suggests that the debate over how to expand monetary and fiscal stimulus is misplaced.”

This matches the frustration and anger at central banks generally and negative rates in particular. Maybe we’ll get more explanation from Mervyn King, whose new book The End of Alchemy just arrived. It promises to answer the question of why we can’t escape stagnation. There goes the weekend. So far it looks promising. At the front of the book, King quotes TS Eliot, whose last line in a poem fragment is “Where is the knowledge we have lost in information?” This is going to be good.

Returning to the present, tomorrow’s payrolls have a chance of halting the dollar slide and sending it reeling sideways. The move is overdone on an exaggerated response to Yellen’s “dovishness,” which is something we can’t really measure. “Lower for longer,” to be sure, but that doesn’t mean “never.” As usual, we advise both traders and hedgers to exit all positions ahead of the inevitable spikes tomorrow morning on the release.