Tomorrow's payrolls are the key for Fed plans

Outlook:

The ECB meeting today will be followed by the usual highly popular press conference. Analysts have been wondering whether the newest economic projections will change the inflation outlook, currently at 1.8% by 2017. It’s hard to see how the forecast can be lifted, given recent data and energy price declines, and maybe it will be cut. If so, Mr. Draghi may extend QE past next September or raise the amount of the monthly purchases. Last week the IMF urged the ECB to extend the program, given threats that include a slowdown in China and volatility in various markets. Some 75% of analysts in a Reuters poll agree extension is coming, but perhaps not today.

We say on past performance, Draghi won’t rock the boat. One thing he doesn’t have to address is Greece, at least not this time. Liquidity at Greek banks has improved to the point where the ECB has reduced ELA to the central bank to €89.1 billion from €89.7 billion, with a source telling Reuters “The ELA cap was lowered due to conditions and inflows normalizing." This is a “yeah, but” moment. The Greek election will be held on Sept 20, with the outcome far from clear, and after that, in October, the ECB review of progress on reform that is supposed to give enough data for the IMF to return to the troika fold. If wishes were horses, beggars would ride.

As for the Fed plans for the Sept 17 FOMC, tomorrow’s payrolls are the key. A low number gives the Fed just the excuse it may want to delay. Yesterday ADP disappointed with an estimate for the private sector at 190,000. The Bloomberg survey overall forecast is 218,000. We don’t like the unemployment rate as a number because it comes from the household survey, which we consider unreliable, to say the least, but still, it’s a watched number and this it’s likely to fall to 5.2%. That’s as close to “full employment” as you can get if you are looking at a single number. Add the U6 and participation rate and baby boomer problem, and we certainly do not have full employment.

All the same, it is an article of faith that “full employment” brings inflation in its wake, even if wage pressure is not yet evident. That tips the argument in favor of a Sept hike, although it may be a “one and done” deal. Also vastly in favor of September is the urge for normalization, expressed by many (including Bill Gross yesterday). The only Fed who uses the word much is Vice Chairman Fischer.

Working against September is the IMF, rightly naming global slowdown and frazzled equity markets. Anyone who thinks they can forecast the Fed from this set of nearly equally matched arguments is probably engaging in wishful thinking. On the whole, we think the Fed is chicken. This is not a slander against Yellen--it was chicken under Bernanke, too (and often just pig-headed under Greenspan).

At a guess, and we are all guessing now, we will get the usual spiky gyrations tomorrow on payrolls, even if the market should be somewhat thin due to the Labor Day holiday. A good number favors the dollar because it favors the Fed in Sept, while a lousy number (under 200,000) sets the euro off on the rise again, no matter what Mr. Draghi says today.

Fun Tidbit: We discovered yesterday that a fruitcake who calls the end of the US financial system imminent and is developing a barter website has picked up on our comments about China. In July we wrote that the first big drop in the Shanghai did not necessarily mean much because fewer than 10% of Chinese participate in the stock market and because Chinese traders are inexperienced in the normal gyrations of established markets.

We were wrong that contagion would not ensue as in the earlier Shanghai surprise, but to be fair, we wrote those remarks before the Aug 11 devaluation and release of Really Bad Chinese data. Besides, everybody and his brother had been forecasting a Shanghai crash for months.

We continue to think that the thesis of growth slowing in China more than we had thought—and we already thought it was slowing more than we were being told—is more important to commodities and other equity markets than the Shanghai per se, but never mind. The real thrust of the fruitcake essay is that central bank ZIRP policies have ruined the global financial infrastructure, and things are going to get a lot worse if the Fed chickens out in September.

This argument is not all that different from that of Bill Gross, reported yesterday. QE and the Twist are government interference in markets with unknown and unintended consequences, mostly of the massive misallocation variety. The difference between the fruitcake and Bill Gross is that Gross is well-educated and experienced, courteous to others and moderate in his language. The fruitcake admits he is self-taught and has no education or experience in international finance. He is rude and intemperate in his language.

It is supposedly “embarrassing” and “hilarious” that we downplayed the Shanghai’s July drop. Well, no. At the time, it was a reasonable deduction based on facts at the time reported by the legitimate press (namely the Financial Times). We define the legitimate press as entities that conduct fact-checking and require more than one source to verify a Fact. What’s embarrassing is to fail to note that events develop and change, and something written in July is not still news in September. And we have also railed against ZIRP (without calling for the end of civilization). Context and timing do count.

Here’s a good example: The author scorns the statement “It’s not a crash; it’s just the end of a ‘market cycle’.” He says “This is the most ignorant non-explanation I think I have ever heard. There is no such thing as a “market cycle” when your markets are supported partially or fully by fiat manipulation.

“Our market is in no way a free market; thus, it cannot behave like a free market. And thus, it is a stunted market with no identifiable cycles. Swings in markets of up to 5 percent to 6 percent to the downside or upside (sometimes both in a single day) are not part of a normal cycle. They are a sign of cancerous volatility that comes from an economy on the brink of disaster.”

A couple of points: modern technology has increased market price volatility. It’s a fact of life that many are having a hard time learning about and accepting. High frequency trading and its tricks (spoofing, etc.) do indeed increase volatility. We cannot expect volatility to remain at 1950’s levels in the radically changed world 65 years later. In the 1950’s, you paid $300 to trade 100 shares. Then we had the Big Bang in 1975, deregulation of brokerage commissions, and volatility changed. In the late 1990’s, we had the internet with both information and trading capability. Volatility changed again.

Smart, statistically-competent market insiders calculate and re-calculate volatility constantly. Knowing what is normal and within normal ranges of volatility is a big deal if you are a fund manager. For what it’s worth, Victor Niederhoffer was one of the first world-class investors who studied volatility and made at least two fortunes from those studies. George Soros said he was the smartest guy who ever traded for him. Niederhoffer crashed and burned, to be sure, but not because he didn’t know market volatility statistics.

Our fruitcake, who is proud of never having gotten an education in international finance or worked in the industry, seems not to know about the primacy of volatility studies. He just throws out his uneducated opinion that a 5-6% swing are not “normal.” People may be entitled to their own opinions but they are not entitled to their own facts. We have had many, many single days where the move was 5-6% (and more). The “flash crash” in May 2010 had the Dow down 9%. Quick, what is the incidence of 5-6% intraday swings in the stock market?

You can Google “average swing in S&P” and get over 1.5 million entries stuffed with data. We have no evidence in this essay that the author checked a single one, let alone Irene Aldridge’s book on High Frequency Trading and how it will (for sure) increase volatility.

We admit that we, too, dislike the pompous “cycle,” but not because it doesn’t exist. The problem is that too many cycles co-exist at the same time—real estate has a cycle of 8 years unless it’s 44 years. The business cycle is 3-4 years unless there is a Major Recession, in which case recovery is 8 years (Rinehart & Rogoff). Yale Hirsh identified the Presidential Cycle in the stock market and the Stock Traders’ Almanac describing seasonal and other patterns over 50 and more year continues to sell like hotcakes. So it’s silly to say we have no cycle when we have a surfeit of cycles.

Moreover, the US markets are hardly “supported by fiat manipulation.” That would be China, alas. It is simply not true that “Our market is in no way a free market.” Does this guy imagine some dark conspiracy in Washington that has the Fed or somebody calling up fund managers on the phone and dictating buys and sells? According to the NYSE, as of the week of 7/31/15, there were 1.256 billion NYSE group shares traded. There were 4.725 million group share trades for a dollar amount of $47.092 billion. Who, exactly, telephoned the traders of those 4.725 million trades? It’s ridiculous on the face of it. Elsewhere he says governments interfere in the markets all the time. Well, no. Bans on short-selling, circuit-breakers and other forms of manipulation are actually very rare in the US.

Those are just a few Facts to offset an intemperate, uneducated rant designed to sell a sky-is-falling scenario. This is not to say the sky is not falling. We can imagine many things going wrong simultaneously. Just not these things and not the way our fruitcake says, and certainly not a legitimate cause of hoarding cash and gold coins in a hole in the backyard.

Maybe we should be flattered that the fruitcake crowd has found our reports. And of course there is no point in trying for a rebuttal. These guys have closed minds. But it’s kind of fun.

Note to Readers: Next Monday, Sept 7, is a national holiday in the US. We will not publish any reports.