Despite this morning’s BLS report winding up slightly opposite of the street undertones -- I.e., consensus was preparing for bad weather clobbering job adds while helping wages and not vice-versa -- it wound up being perceived as sturdy enough to dust off conversations of perhaps a rate hike in June.
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CME Group March Gold futures tumble $28.00 to $1168.00/oz., the U.S. dollar skyrockets (EUR/US$ 1.0874 -154) while the U.S. 10-year Treasury presently yielding a whopping 2.24%, matching levels not seen since January all on what is deemed a robust jobs report -- keeping the window faintly tilted to a June Fed funds rate hike. According to CME Group Fed funds futures, there is today ever so slightly more hope for a June hike than yesterday and, the probabilities of a June hike equal the probabilities assigned by traders before the last BLS report in February.
Whitepapers, Fed funds futures probability trees, along with this morning’s BLS report aside, I do believe the Fed will be raising rates sooner and more aggressively than the market is currently expecting. Monetary policy in the U.S. has been extremely easy for a very long time and, at some point, our economy must learn to heal on its own and that time is ripening as we continue to see material improvements in the labor market -- not just in jobs created, nor simply in wage growth metrics, but even the higher paying industries -- I.e., Information, professional & business services -- are seeing a mild yet steady uptick in pay scale.
Recall last month’s BLS report was the sturdiest in years. Not only in huge job gains but substantial upward revisions to previous months. Most importantly, the report showed a strong bounce in wage growth, a development which will work wonders to FOMC confidence levels of inflation returning to a target level of 2.0%. Certainly, low inflation and/or disinflation is a real concern however, I don’t see the current members falling for the “banana in the tailpipe trick” again in that inflation -- like water -- will always find its way and consistent job creation and wage growth will swiftly bring about inflation.
No matter what the BLS report suggests today, no matter whether Fed funds are pricing in a 30, 40, or 60bps rate hike by year-end, whether that timing is June, September, no matter whether Yellen drops “patience” to give herself flexibility, no matter if oil has stabilized, no matter how tight-money campaigners are constantly shifting their arguments -- it’s about inflation; no, it’s about reliable market functioning; no, it’s about financial constancy -- it will end up with the same bottom line: rates will rise.
Why rates will rise again….soon…
First, the halving of oil prices -- along with many other commodities including -- aluminum, copper, iron ore, since June, 2014 has played an enormous role in tempering inflation and inflationary expectations. This was a shock to the market as things fell faster and farther than anyone imagined yet, like most things, markets are quick responders -- adapters to change. Once, prices normalize we will be in “re-set” allowing people/markets to breathe again -- giving way to steady inflation. Second, Purchasing Managers Index numbers have been on a general upswing -- most notably in Europe -- providing further evidence that growth, albeit uneven, is generally moving in the right direction. In addition, foreign ownership of U.S. treasuries has risen considerably since the middle of the 1990s and has been keeping pace with the growth of the market since 2012 and now stands well over 50%.
Overbought? Perhaps, and especially if you recognize not so much the buying has come from official buyers (I.e., foreign central banks and sovereign wealth funds). The much-discussed “flight to safety,” which is believed to underpin the dollar, largely reflects the huge policy-driven demand for dollar reserves from emerging-market central banks, this is, in my view, indicative of crowd behavior and, as account balances continue to rise outside of the U.S., we could easily experience wholesale selling of our Treasuries.
How to play it
Even if the Fed raises policy rates this year, it may be a long time before the real cost of money is materially positive again. How to play it:
- Fixed income markets are nearly back to where they were in early 2012 -- unless you want to be a “coupon clipper”, I wouldn’t buy US 10-Year Treasuries as we will most likely see a yield of 2.75 by year end.
- The U.S. dollar is quite expensive to own yet, it’s too close to lift-off (I.e. rate hike) to sell. Be nimble.
- At the end of the day, U.S. monetary policy will be a drag anchor over golds head. As a trader, I would sell any strength in the price action. As an investor, I would be patient and accumulate (long-term perspective) accordingly as we are in the midst of a policy experiment that has never been attempted.
- Buy Japanese and European equities vs. U.S.
- Add European cyclicals -- especially in the consumer discretionary sector. Stay defensive about defensives.
- Buy U.S. bank stocks.