On Friday, we got an abysmal NFP print.
And that should have sent stocks soaring right out of the gate.
As we explained here earlier today, bad economic news has traditionally been good news for equity investors and traders in the upside down environment that has largely characterized the post-crisis world.
By the end of the session, the world had come to its senses. Almost. Stocks closed only marginally lower (although the Nasdaq did take a moderate hit) presumably reflecting the fact that now, the Fed has a real, “data-dependent” reason not to hike in June. And probably not in July either unless June’s NFP print is a real blockbuster.
If we get a move lower in crude over the next few weeks, well then that’s all the better in terms of forestalling a hike.
What you’re seeing here is a market that is having an exceptionally difficult time adjusting to a reality wherein a Fed tightening cycle is both imminent and implausible at the same time. More importantly, everyone - investors, the FOMC, the BoJ, the ECB, everyone - has become way too myopic. Here, for instance, is the first sentence from a Reuters article out today on the jobs report:
“The U.S. economy created the fewest number of jobs in more than 5-1/2-years in May as manufacturing and construction employment fell sharply, which could make it harder for the Federal Reserve to raise interest rates.”
All of that may be true but why, exactly, is this some kind of surprise? Was “manufacturing employment” strong before May? Spoiler alert: No.
In short, nothing changed today.
At a certain point, the idea that because the American economy isn’t what it used to be is definitively negative becomes ridiculous. Yes, this is a services-driven economy. “Stuff” is made outside this country where labor costs are dramatically cheaper. That’s not inherently “bad.” It’s just the way business works. It makes no sense to say “I own stock in a company and I want that company to maximize the value of my stake” and then to turn around and say “I want to bring jobs back to America.” You can have one or the other. But you can’t have both. Period. Sorry. It’s not about morality, or about patriotism. It’s about economics. And math. And the numbers, as they say, don’t lie.
It was a valiant effort in terms of reflating asset prices and rescuing the global economy from the crisis, but it’s been eight years. Eight. Years. Interest rates have to be normalized in the US, and eventually in Europe and Japan.
And contrary to what you may read elsewhere, they will be normalized - eventually. Why? Because if they aren’t, then the system will stop working. Eventually, banks’ NIM will drop to zero, at which point negative rates will be passed on to depositors as a deposit tax. At that point, it’s game over. People will pull their cash.
For some reason, people can’t seem to connect the dots between that supposed “crazy” supposition and the fact that in Denmark, they have negative rate mortgages. Let’s reiterate: negative rate mortgages are a real thing. You don’t have to believe it if you don’t want to, but it’s real. RIght now. It’s actually happening. And that’s the flip side of taxing depositors. If “normal” is charging interest on home loans and paying interest to depositors, then “abnormal” is a negative rate mortgage and taxing depositors. Well, negative rate mortgages are here. So what do you think is next for depositors?
That can’t happen and it almost certainly won’t happen. Either central banks upend the entire system and usher in a new, cashless, centrally planned society, or eventually, rates go back up and the market reasserts itself. So you kind of have to ask yourself if you see a Si-Fi movie in your future. If you don’t, then you need to think about what it means for your assets when rates rise.
Thankfully, Goldman is here to tell you.
In a note out Friday, the bank attempts to quantify the loss associated with a 100 bps (that’s just 1% mind you) rise in interest rates. Here’s Goldman’s assessment:
“Combining a duration estimate of 5.6 years with a total notional exposure of $17trn, and current Dollar price of bonds of $105.6, indicates that, to first order, a 100bp. [That] shock to interest rates would translate into a $1trn market value loss. [That is] over 50% larger than the market value lost in the 1994 bond market selloff in inflation-adjusted terms, and larger than the cumulative credit losses experienced to date in the non-agency residential mortgage backed securities market.”
To be sure, there are a lot of caveats and assumptions built into the model which you can read about if you can get ahold of the whole note, but the message here is clear. Here’s how Goldman puts it:
“...even if there is not a large net social loss from a rise in rates, the $1trn gross loss estimate suggests that some investor entities would likely experience significant distress.”
Why, yes. Yes, a 1 trillion dollar loss does seem to “suggest” that someone would experience “distress.”
At the end of the day - or, “at the end of the week” as it were - you need to think, as an investor and a trader, about Friday’s NFP number.
Not because you necessarily care one way or another about the unemployment rate. And not because the way the market moves should necessarily matter to you (if you’re a skilled trader you can make money in any market, especially if you trade options).
But you should note the following. The only options here are, i) normalize policy, or ii) change the face of monetary and fiscal policy history by either ushering in helicopter money or doing away with cash and thus the effective lower bound. Needless to say, the former is more likely. And that means you’re about to see fixed income investors take a massive loss.
Trade accordingly.