The September US Nonfarm Payroll may be the last piece of the Federal Reserve taper puzzle.  Markets have barely begun to react to the possibility of higher US interest rates. Equities, Treasuries and the dollar could face a period of rapid and substantial adjustment. Join FXStreet senior analysts Valeria Bednarik, Yohay Elam and Joseph Trevisani for a look at the wide range of possibilities.


Joseph Trevisani: NFP of course...what a Fed taper will mean for the global economy...will other central banks follow? Will markets do the traditional adjustments for a Fed policy change?

Yohay Elam: The dollar has been broadly higher since the Federal Reserve signaled tapering on September 17. Can this ascent be fully attributed to the Fed or is fear driving flows into the dollar?

Joseph Trevisani: I think it is the Fed.  Fear is limited, Evergrande didn't blow up Chinese markets, I guess you would have to say yet, and the US debt limit is a media political event, nothing else.

Valeria Bednarik: Probably part of both. But I keep remembering Fed Powell´s words, when he said that one good employment report would be enough to convince him about starting tapering. 

Joseph Trevisani: Yes and he has had two, with one ok one pending.  Perhaps the question should be, would another lousy NFP report dissuade the Fed from tapering?

Valeria Bednarik: That's a good one indeed. Still, he did not particularly referred to the September report. I bet market participants will wait to see October reading before thinking of a no-tapering scenario.

Yohay Elam: I think it would take another sub-300K NFP to stop the Fed.

Joseph Trevisani: I think taper is the Fed's default position.  My question is how much market adjustment is still waiting?

Yohay Elam: Indeed, taper seems like a done deal, barring a disaster. Regarding markets, perhaps they will be more sensitive to the wage data this time, as they seem more tuned to inflation-related figures.

Joseph Trevisani: The US 10-year yield is 20 points from its March 31 high of 1.746% and 50 to 100 points from its pre-pandemic range.  That is a lot of potential adjustment.

Valeria Bednarik: Agreed. However, higher yields are no longer a thing of highs, or pre-pandemic levels. A spike in yields is enough to spur speculation of mounting inflationary pressures and speculative interest rushing into pricing it in.

Yohay Elam: Good points there: is the pace of change in yields more significant to the dollar? Or the absolute level?

Joseph Trevisani: The pace of change I think, more than the absolute level of yields.  Remember the old debate about the neutral level of interest rates a few years ago. Even then there was no consensus at all, now I would say it is closer to no clue.

Yohay Elam: Neutral level of rates, very theoretical...

Joseph Trevisani: The Fed is acknowledging, grudgingly, that inflation is a bigger problem than they predicted.  Which to Fed followers is hardly a surprise.

Valeria Bednarik: Yes. Stubbornly high inflation seems to be a surprise only for policymakers.

Yohay: The Fed's inflation forecasts were too high for many years. It took them time to acknowledge it, and now things are changing again.

Joseph Trevisani: Truly. The Fed talks its inflation book.

Yohay Elam: However, they may still be right regarding the nature of this inflation – a one-off jump in prices followed with a return to slow rises, rather than rising prices now and ongoing price rises later.

Joseph Trevisani: Yes, but heading into the winter, energy prices are making a very unpleasant rise, especially in Europe.

Valeria Bednarik: Another good point there.

Yohay Elam: Yeah, Europe is going to suffer... until it opens up Nord Stream 2. I think Russia is putting deliberate pressure.

Joseph Trevisani: Prices here are rising sharply also, though not as much. Russia has no incentive to increase supply until prices are higher.

Valeria Bednarik: Putin said to be thinking about a “carefully” possible increase in gas supplies, as the current hike in prices is not beneficial for Russia.

Yohay Elam: It is beneficial for Russia to extract concessions from Europe...

Joseph Trevisani: It is not beneficial for Europe to depend on Russia for energy.

Yohay Elam: Indeed, the question is: will soaring energy prices push overall inflation higher? Will employers agree to attach salaries to inflation? I don't think we're there yet

Joseph Trevisani: Energy is the basic commodity of industrial civilization, it affects everything.

Yohay Elam: In 2011 high energy prices didn't turn into broad price rises. Oil remained elevated until 2014, then crashed, while core inflation remained stable during the upturn and the downturn. The world is in a much better place than in 2011, so there's much more demand. But I'm not sure it is enough for triggering persistent price rises.

Joseph Trevisani: Alone it may not be, but with the supply-chain and labor market issues that are not abating, there is basis for concern.

Valeria Bednarik: Meanwhile, the dollar is generally strong, with the EUR among its weakest rivals. What do you think is going on there? Could it be central banks' imbalances?

Yohay Elam: Regarding the euro, it's a mix of the energy crisis and reports of a new QE program to replace PEPP.

Joseph Trevisani: Also I think US rates. There has been much Fed backtracking on rates since that March 31 high in the 10-year. Markets have not been very aggressive in pursuing the rate logic of a bond taper. Once burned twice shy. Even if the NFP results are positive tomorrow, it is three weeks to the FOMC meeting.

Yohay Elam: I think the Fed has been doing a good job at communicating the taper – any stock market dip is far from the taper tantrum of 2013. I think that if the NFP tops 400K, only a 15% market fall would cause the Fed to rethink tapering. CPI inflation is not going to crash enough to change their minds. Hardly going to fall.

Joseph Trevisani: The current Fed taper talk began almost five months ago.  I think back to the Yellen Fed which kept raising rates without and of the traditional signs.

Valeria Bednarik: I don't think a 400K NFP would affect the tapering decision. As you said, it's a done deal.

Joseph Trevisani: I think it is. Only the month of the announcement and I think Yohay is right, it would take a very bad NFP to delay the taper to December.

Yohay Elam: Either a horrible NFP or a market crash in my opinion. I remember that back in 2013 or 2014 Bullard wanted to pause the tapering process because markets were jittery. How much do you think the Fed cares about Wall Street?

Valeria Bednarik: More than they acknowledge… much more. Tapering discussions have been on the table for months, and they started with "thinking about thinking". Policymakers don't want any market jitter. Wall Street is near record highs and we take tapering for granted, so that's a goal for them.

Yohay Elam: Yeah, no taper tantrum, mission accomplished. We tend to talk about how the Fed impacts markets, but it's a bidirectional relationship. 

Valeria Bednarik: Yep, it is

Joseph Trevisani: I think it depends somewhat on context.  When the Fed drops rates, a rising market works to alleviate deeper economic concerns, the market discounts the future.  In this case, you might have a substantial correction but with a, hopefully, strong economy.

Yohay Elam: Yep, so, is it more of "buy the dip" in stocks? And more dollar gains with yields?

Joseph Trevisani: Or dips in the dollar.

Valeria Bednarik: Agreed, we will have some volatility but it won't be a catastrophe.

Joseph Trevisani: If the economy recovers strongly, that will, in short order, determine equity direction, even if there is an interim sell-off.

Yohay Elam: Every downfall is an opportunity.

Joseph Trevisani: In a long-term consideration, I wonder if we have ended the long decline in inflation.

Yohay Elam: This is more than 2011 as demand is super strong, but also far from the 1970s. Back then, many workers were unionized and most of them had automatic salary raises related to inflation. This is not the case now. I think we'll have issues with supply chains and labor mismatches through 2022, but no persistent inflation.

Joseph Trevisani: Yes, but you do have, now as then, an enormous unfunded US deficit. Lyndon Johnson didn't want to pay for the Vietnam War with tax increases. Governments never learn.

Valeria Bednarik: Bottom line, the Nonfarm Payrolls report could be a make it or break it and spur nice market's action for a change.

Joseph Trevisani: The US economy is probably stronger than it appears, restrained by labor and supply-chain issues. The pandemic seems to be on the way to becoming endemic, if the US is the most obvious recovery and, or when the Fed tapers, I think you have six months or a year of dollar ascendancy.

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