Global financial markets now display an interesting dynamic. This dynamic is likely to see volatility spark back to life over the coming weeks or months, despite rising global geopolitical tensions, though this view has nothing (at least not directly) to do with North Korea. This may sound like a vague timeframe for a prediction of sharply higher volatility, and, in a sense, that is the essence of the problem.
In a world where money is looking for ideas and more significantly looking for yield, the distortion of global zero-interest-rate policies, yield-curve flattening and non-conventional monetary easing has driven capital into relatively few areas globally. If we add in the recent low (but importantly positive) growth/low inflation backdrop, capital flows have been concentrated further. Long equities, long bonds and essentially short volatility trades are becoming an increasing market vulnerability.
Sayings such as "picking up pennies in front of a steamroller" and "the straw that broke the camel’s back" are likely to be frequently used and sagely descriptive after the event. In these analogies, what constitutes the "pennies" is fairly obvious. What ultimately constitutes the "straw" is less clear.
Tuesday afternoon's release of the US Job Openings and Labor Turnover Survey (JOLTS) effectively showed that the gap between job openings and actual hirings is at its widest ever. One interpretation (likely favoured by the Federal Reserve) is that it is a result of a tightening labour market that will ultimately result in higher wage pressures (presumably then narrowing the gap). However, at the moment, there seems to be something of a Mexican standoff as firms are keeping wages at levels that do not attract new workers at the desired pace. The arch-dove on the Federal Open Market Committee Neel Kashkari’s take on the issue of companies struggling to find staff is refreshingly direct: “If you are not raising wages, then it just sounds like whining.”
A similar dynamic is evolving in the UK. Despite what the Bank of England describes as an “increasingly uncertain environment”, British companies are having greater difficulty hiring workers, as unemployment has fallen to its lowest in more than 40 years. The latest BoE business survey reported an increase in recruitment strains, which are “gradually broadening across sectors and skill areas”. The bank also noted that investment intentions were “modestly positive overall”, but that uncertainty around the trading environment was weighing on some firms’ longer-term spending plans. One result of the uncertainty is that employers’ pay growth expectations remain fixed around 2-3% per year.
“The issue isn’t just jobs... the issue is wages” — Jim Hightower
In the UK, the failure to attract staff, or more specifically the lack of (ability or) desire to raise wages, is due to the “persistent uncertainty over Britain’s future relationship with the EU” as the FT was eager to point out this week. In the US, the "uncertainty" is likely more a function of fiscal policy (tax and healthcare implications) as well as concerns over the underlying strength of the consumer, public finances, and growing geopolitical tensions.
From our perspective, the potential for an acute market pivot is growing substantially. Both the UK and the US are approaching levels where currency valuation accounts for no monetary tightening over the policy forecast horizon. Even a modest reduction in the uncertainty surrounding US fiscal progress or compromise, presidential credibility (admittedly seemingly less likely) or signs of employers paying up for staff would have a potentially dramatic impact on US yield curves and the USD. In the UK, any clarity on the intention of the government’s EU negotiating stance, or agreement on transitions would likely have a similar impact.
“Nothing rises quicker than dust, straw or feathers” — Lord Byron
Equity markets are very keenly priced, relative to our view of increasing risks of an acute pivot in the USD, GBP and their respective yield curves. Corporate action on wage levels in the UK or the US, in this regard, could be a game-changer for inflation expectations, monetary policy and the respective currencies, in our view. The straw that broke the camel’s back? Either way we expect volatility to rise, perhaps significantly.
The "jolt" to the USD from the JOLTS data was significant, if tentative, in highlighting this, though US president Donald Trump’s "fire and fury" comments dampened the impact by creating a far more worrying Mexican standoff. However, if employers blink first, we expect a sharp bullish pivot for the USD and GBP.
Watch out for a sharp pivot in the dollar and the pound
if employers blink first on wages. Image: Shutterstock
— Edited by John Acher