Michael Every, Rabobank’s Head of Financial Markets Research Asia-Pacific, shares my view on today’s bizarro markets:
If one ever wanted a perfect example of just what a mess we are in globally, look at the market reaction to Friday’s payrolls data. Even with the caveats offered in the last Daily (that the data are an often-revised, backwards-looking, lagging, and artificial “birth-death model” statistical rounding error) what we saw was a very healthy report.
Jobs rose 224K vs. 160K expected, even though the unemployment rate rose a tick to 3.7% and wage pressures again remained absent. In short, despite genuine fears of recession ahead, these often-revised, backwards-looking, lagging, and artificial “birth-death model” statistical rounding error say that all is well and hence the economy–on the surface–is just fine. That should have been a gift to the Fed presented on a silver plate – but it wasn’t.
Why? Because post-release, US Treasury yields naturally went up again, with 10s back to around the 2% level… and yet US equities went down, while USD also went up. So it would seem the crucial stock market and its presumed rational pricing basis of a projected flow of future corporate earnings would rather have juicy rate cuts than a healthy US economy. Which, as I said, speaks volumes about where we are now globally. And it also risks presenting the Fed’s head on a silver plate.
Just what is the Fed supposed to do now? On the measures they look at the outlook is good and trade wars aren’t escalating (yet); interest rates are still very low by historical standards; those all-important equity markets remain close to record highs. So is Fed Chair Powell, who testifies this week, going to make clear that while he is ready to step in if needed, right now he isn’t?
If so, can we expect an apple in his mouth? Equity markets want those rate cuts.
Markets are continuing to sweat this month’s upcoming Fed announcements. Investors want to see bad data, so that Papa Powell will ride to the rescue with more delicious liquidity.
But with record-high asset prices and booming jobs, can Powell justify the cuts the market is counting on?
Heading into July, investors pegged the odds of a 50 basis point rate cut near 50%. Friday’s number put a bullet in those hopes:
Market prices need to adjust downward a lot further for that change in expectation. They haven’t yet.
Also, how can Powell justify the now-baked-in expected 25 basis point cut? Prices are sky-high, inflation is very low (by the Fed’s yardstick), and jobs are a-rockin’. What is the rationale for cutting here when rates are already so historically low?
And if Powell decides he can’t justify cutting and surprises investors by keeping rates unchanged, that could be the pin that causes the next market correction.