NFP report disappointed and yet the dollar did not fall

Outlook:

We can’t drop Friday’s nonfarm payrolls report like last week’s trash because the report disappointed and yet the dollar did not fall. We can’t really credit the 2.5% y/y hourly wage gain—it’s actually only 8¢--and there are plenty of negatives that the grumpier analysts seize upon, like the fallback in the participation rate (to 62.8%) and the piddly drop in U6 to 9.7%, which some consider the “real” unemployment rate.

Whether anyone admits it or not, the numbers are fishy. For one thing, the total labor force contracted by 362,000. With baby boomers retiring at a pace said to be 10,000 per day, this contraction in the labor force looks too small. This week we get the Small Business Optimism Index and JOLTS, which may enhance our understanding of the labor market.

Right after the payrolls release, the CME reported the probability of a June rate hike fell to 6%. July gets a 21% chance, September, 36%, November, 38%--and you have to go all the way to December to get more than 50% (53%). By Feb 2017, it’s 56%.

We say September is probably off the table because it is too close to the presidential election and for November, the chance should be zero for the same reason. We have to get a hike in June or July for the Fed to maintain a sliver of credibility on the two-hike scenario—and the market does not believe the data warrant it.

Moreover, the FX market doesn’t believe it, either. Reuters reports the CFTC Commitments of Traders report shows net short dollar positions at $6.46 billion for the week ending May 3, the largest since the Feb 5 week. This is a big gain over the week before at $4.19 billion and the third straight week of net short dollar positions. Before then, speculators had been long the dollar since May 2014. The COT re-port shows that traders were willing to give the Fed the benefit of the doubt for almost two years, up to mid-April. Now they have thrown in the towel.

And yet the 10-year yield is higher, not lower as it “should” be if the market believes the Fed is in full retreat from two hikes. The 10-year note index closed 1.779% from 1.747% the day before and is quoted at 1.787% this morning. Market News reported a violent reaction to the payrolls report. “It was trading at around unchanged at 1.744% heading into the report, gapped to a low yield of 1.704% and then re-bounded to 1.770%. The large whipsaw could have been profit taking at the highs and the setting of new shorts. There were reports of better buying during the backup in yields. However, many were licking their wounds as they covered shorts at higher prices than necessary.” The bond market is confusing. “Many already covered their shorts and some might have gone long. The 10-year was yielding 1.93% at one point last week. It is also important to remember that Treasury will be selling $24 billion new 3s next week along with $23 billion new 10s and $15 billion new 30-year bonds. That is a lot of supply unless the recent rally is validated.”

The factors don’t mesh well together. In fact, they connote a giant disconnect.

To make matters worse, we have two opposing views from two important regional Feds. The all-important NY Fed Pres Dudley says it’s a “reasonable expectation” that the Fed will raise rates twice this year. The economy is still on track and we can expect 2% growth this year (the Atlanta Fed has 1.7% so far for the current quarter). The global situation as “dramatically better,” and financial conditions have eased “considerably.” Not much disturbs him. The risk of recession is “quite low.” The only danger is an unexpected shock to the economy. And he is not considering negative rates at all, now or in the future.

Sounds reassuring, but then look at the interview of St. Louis Fed Bullard, who says he can’t time the next recession but it’s likely to come before the Fed gets the chance to normalize rates. One big fat problem is the “tension” between slow growth and a strong labor market. The Fed generally considers that jobs trump GDP, but low productivity growth is to blame for not getting the expected GDP growth. And it’s a terrible thing for Fed credibility that 2% is named and you end up with only 1%. “It means stabilization policy is not going to work as well because confidence in the central bank has eroded.” Inflation expectations are not at the right level—and worsening over the past two years (summer 2014). Bullard expected oil and inflation expectations to “decorrelate. And it still hasn’t happened. We’re coming up on two years. I’m starting to feel like you just have to take the signal at face value.”

Okay, so which is it? Dudley’s “we’re all right, Jack,” or Bullard’s “recession is coming”? ECRI chimes in with a report titled “Flawed Assumptions and Grand Experiments” (https://ecri-prod.s3.amazonaws.com/downloads/1604_MinskyConf_ECRI.pdf). The gist of the paper is that the real source of growth is labor market productivity and that has been lacking due to a shortfall in capital in-tensity, i.e., capital investment that creates productivity. To try for stimulus via monetary policy alone obviously doesn’t work and is the “flawed assumption,” or rather one of them.Okay, so which is it? Dudley’s “we’re all right, Jack,” or Bullard’s “recession is coming”? ECRI chimes in with a report titled “Flawed Assumptions and Grand Experiments” (https://ecri-prod.s3.amazonaws.com/downloads/1604_MinskyConf_ECRI.pdf). The gist of the paper is that the real source of growth is labor market productivity and that has been lacking due to a shortfall in capital in-tensity, i.e., capital investment that creates productivity. To try for stimulus via monetary policy alone obviously doesn’t work and is the “flawed assumption,” or rather one of them.

In fact, the growth rate has been “stair-stepping” downward since the 1970’s. [Not to be a pest, but Greenspan hinted at the same thing and also named productivity.] And after a big recession, it ain’t necessarily so that the recovery is of equal strength. The data does not bear out this thesis. We are not “owed” a return to the previous high long-term trend. ECRI clearly has a case of self-righteousness that gets under your skin, but the data is certainly interesting. Maybe what we face is not “secular stagnation” but rather a permanently lower growth trajectory. The ECRI paper came out over the weekend and got zero press attention, so maybe it’s crackpot.

What happens next? The preponderance of the evidence points to a dollar drop after this nice little respite. But maybe not. We may have to wait for the Wednesday bond auction or even Friday’s retail sales. Until then, stay nimble and question everything.What happens next? The preponderance of the evidence points to a dollar drop after this nice little respite. But maybe not. We may have to wait for the Wednesday bond auction or even Friday’s retail sales. Until then, stay nimble and question everything.

		Current	Signal	Signal	Signal
Currency	Spot	Position	Strength	Date	Rate	Gain/Loss
USD/JPY	107.91	LONG USD	NEW*WEAK	05/08/16	107.91	0.00%
GBP/USD	1.4462	LONG GBP	WEAK	04/12/16	1.4309	1.39%
EUR/USD	1.1390	LONG EURO	WEAK	03/11/16	1.1094	2.98%
EUR/JPY	122.94	SHORT EURO	STRONG	05/02/16	122.33	0.10%
EUR/GBP	0.7876	SHORT EURO	STRONG	05/02/16	0.7864	-0.14%
USD/CHF	0.9695	SHORT USD	WEAK	04/29/16	0.9632	-0.44%
USD/CAD	1.2913	SHORT USD	STRONG	02/01/16	1.4031	8.40%
NZD/USD	0.6832	LONG NZD	STRONG	02/01/16	0.6478	5.50%
AUD/USD	0.7354	SHORT AUD	NEW*STRONG	05/08/16	0.7354	0.00%
AUD/JPY	79.38	SHORT AUD	STRONG	04/02/16	81.17	2.94%
USD/MXN	17.8596	LONG USD	NEW*WEAK	05/06/16	17.9418	0.00%