The Matrix: Reflections of a strategist
- NFPs should surprise to the upside
- The awful impacts of a low yield world
- These cowards don't deserve to lead us
The May US NFP published in the first week of June was just about the worst miss in 7 years. The market had expected 170,000 new jobs but the paltry 38,000 it got, plus downwards revisions of previous numbers, were a major disappointment. So it’s kind of like you're expecting your year-end bonus, then you get TOBASed. T-O-B-A-S is the inelegant way of saying fired, it’s Taken-Out-Back-And-Shot. It's something that happens every day in this business.
Anyway, that one data point in early June threw a monkey wrench into the hawkish chorus and growing expectations of US policy moves in June, July or September. But since then, US economic data has continued to accelerate to the upside with beats in GDP, ISM manufacturing and ISM non-manufacturing. Love it or hate, US economic data is on top. And the world aside, we should already have gotten rate hike numero duo out of the way. I still think US inflation will surprise to the upside this year.
The chart below shows the Citi US Economic Surprise index. As you can see its been one accelerating trend upwards (positive economic surprises), the dotted red-line was the dismal one data point NFP miss on June 3.
Now that was one big surprise:
No, no, people. Remember what I said about the Fed? They are the last ones to know whether or not they are going to do anything. Remember 2016, the September 180 degree turn to dovish, then October and another 180 degree turn to hawkish that resulted in a December hike? They have the backbone of a jellyfish and the consistency of inconsistency.
So for those looking to play the event:
I think the potential asymmetrical pathways are long USD (versus GBP, EUR, JPY, CHF), with sterling on the short side of USD being particularly appealing given that it’s the weakest hand out there there's a Bank of England meeting next week. Mark my words. The BoE will cut to zero in the second half of this year, the UK slowdown is as inevitable as they come. We’ve had maximum one-day market price pain, we need maximum UK economic/EU exit negotiation pain. Think of GBP like the fat bleeding kid, in a pool of sharks, with ankle weights on.
I also think in the very short term US yields have tightened way too much, so short US treasuries for the event should have an asymmetrical slant.
The vol arket is sleeping on the event today. My options desk is telling me the implied vol move in EURUSD today is about 60bp (down 10 bps from yesterday), versus an average of 100-150bps (+67% to +150% current vol) than we’ve previously got from NFP days.
Now don’t confuse the tactical (above) for the strategic (below)
Long-term yields lower ‘forever’
As some of you know, I was until very recently (pre-Brexit) of the view that the Fed, US economic strength and the gradual rise of US rates would usurp or at the very least stop the structural drop in global yields I now actually think that post Brexit, the yield compression trade has not only got a life line of at least another 3-5yrs but it will actually accelerate!
It's one thing if you and I are pension/asset/hedge fund/ managers looking for yields and returns in a falling rate environment. But it’s a whole different ball game when there is a consensus awareness (we are not yet there) that pretty soon just being flat +0.0%, will be outperforming in a negative rates world. And capital preservation will trump trying to get returns. And I would argue that people would get much more visceral in protecting what they have (capital preservation) than in chasing returns (capital appreciation).
Again, gold/silver (through the miners) are going to the moon, destination Mars. Yields structurally lower 3-6-12 and potentially 18-24 months down the line. I think US 10-yrs currently at 1.38% are easily sub 1.25% by end of 3Q and easily sub 1.00% by year end. Similar to what I said in December last year, you actually want the Fed to hike, because on that day you want to pick up all the US bonds you can handle.
With things such the Bank of Japan in the process of shifting their entire yield curve into negative territory and in essence, lowering their interest rate commitments – the bond, housing and equity bubbles around the world don’t look set to end any time soon.
So far we have the Swiss completely negative on the yield curve. Japan are negative up to about 18-yrs, Germany to about 14-yrs, Italy with all its issues is negative to about 3-yrs. The US, UK, Australia, New Zealand, Norwegian and China are still in positive across the yield curve. Note, we are not even talking “real interest rates here” which will obviously be lower given inflation. And we’ve not even taken into account potential EU/Eurozone break up (or perceived increased break up risk) nor potential China devaluation – which would be Brexit x 10 and then some.
Apart from the moves we’ve seen in sterling, UK gilts and Italian (EU) banks and Italian equities, if you are confused about the price action post Brexit then that’s okay, it means your mind is working!
I had the pleasure and honour of speaking at a great CFA event last week here in Singapore. I pointed out that Brexit had nothing to do with EU/Eurozone, it had to do with people being fed up with overpromises and under delivering. If you don’t know who the elite are congratulations you are the elite. And don’t be surprised that when global growth is petering away and things are leaner, the fact that only a small percentage of the population goes to an exclusive club of universities and end up in institutions running, policing and guiding the rest of the country, that there are going to be some serious misalignments of interests.
I am not sure what the answer is but I think in the future one or two hundred years from now the most successful countries will be run like good businesses, with clear transparency andaccountability. No system is perfect by any means, but that would be a good start.
Have a great weekend everyone and good luck out there.