Well, that escalated quickly.
Markets are reacting precisely as one would have expected after two solid weeks of hawkish Fedspeak and it’s not entirely clear how everyone feels about things. Maybe it’s just because the holiday limits news flow as well as overseas volume, but there seems to be a palpable sense of caution in the air ahead of Friday’s NFP report.
10s plunged the most in week, reacting of course to Yellen’s “conversation” at Harvard where she got a nice medal for a “lifetime of visionary and principled service.” The bond market got the message...
(Chart: CME)
...so did the USD…
(Chart: Bloomberg)
...and so did gold and Brent which, as Bloomberg notes, broke below $1,200 and sunk 0.8%, respectively.
Ok, so not much of a surprise there. Just markets reacting to a band of bureaucrats who have been trying desperately for going on three weeks now to “correct” a communications strategy that apparently went horribly awry in March.
And those same bureaucrats were back at it on Monday as St. Louis Fed chief James Bullard spoke to reporters after delivering a speech in Seoul. Here’s what he had to say:
"My sense is that markets are well-prepared for a possible rate increase globally, and that this is not too surprising given our liftoff from December and the policy of the committee which has been to try to normalize rates slowly and gradually over time. So my ideal is that if all goes well this will come off very smoothly."
Now first, it’s not clear why Bullard thinks global “markets are well-prepared for a possible rate increase.” They certainly didn’t seem prepared in January. So unprepared were they in fact that China started to convulse again, crude plunged into the 20s, and risk at one point was on pace for its worst start to a year in history. As in, ever.
And as for this: “...my ideal is that if all goes well this will come off very smoothly.” I’m not sure what the counterfactual would be there. “Ideally, I’d like this to go very poorly and everyone panics”, maybe?
Anyway, the Fed’s change in tone was abrupt and seen by the market as an alarming about- face. The risk of course, is that the market matches that with a similarly abrupt about-face and that the repricing along those lines is violent.
For me, that’s pretty much the long and the short of it.
But remember, analysts have to earn their keep and you can always count on Deutsche Bank’s “US Fixed Income Weeklys” to provide a tortuous assessment of all the possible outcomes and how they may or may not interact with each other. Here’s an excerpt from this week’s installment:
“The immediate Fed issue is whether to squeeze a summer hike. Right now unless the (payroll) data materially disappoints it seems likely that the June FOMC will precommit to a July tightening. This has the advantage for the Fed to leave open an option for two hikes this year as per the March FOMC dots as well as the nicety of the “off cycle” precedent. As long as the dots don’t change we don’t think it is material for now whether the Fed hikes in July or delays. The second hike, if it comes, would be year end and there is plenty of time to determine whether or not the expansion is losing momentum and the extent to which a renewed Fed time out is required. The key is containing any rise in real yields – the policy error comes if real yields return to their December 2015 highs, around 80 bps in 10s with the dollar index, DXY for example near 100. Not only would this suggest a reversal in the recovery of global central bank liquidity growth along with renewed reserve loss pressures but also there would be renewed concern around other G2 “easing” (Japan, Europe) to counter Fed tightening for overall global growth whereby a) we already know beggar thy neighbor is ineffective when the neighbor isn’t growing and there are other beggars in the mix (emerging markets - China) and b) the direct impact of a stronger dollar exacerbates commodity based emerging market growth.”
Sarcasm aside, those weeklys from DB are actually really good notes and the lead analyst on them is pretty darn bright. I just find it amusing that people spend so much time trying to catalogue every conceivable outcome when the number of variables is so large and, more importantly, when the very same people trying to catalogue all the outcomes themselves influence the very same outcomes they’re trying to catalogue!
Ultimately, the NFP print is the potential landmine this week, although it’s difficult to imagine we’ll get a number bad enough to reverse the Fed’s rhetoric at this point. I’ll close with a bit from BofAML on Friday’s jobs number and the USD:
“Dollar risks are asymmetric in our view heading into next week’s non-farm payrolls report as the Fed recently pulled up market expectations for a summer hike amidst modest data improvements. The USD has responded positively to the Fed’s hawkish tone, but with the market pricing a 70% chance of a July hike already, a lot of good news appears to be priced already. Indeed, based on real yield differentials, the USD looks pretty fair here.”
