The U.S. unemployment data released on Friday was extremely positive on two measures: Nonfarm payrolls increased by 288,000 and the unemployment rate dropped from 6.7 to 6.3 percent. The soft side of the numbers was that the average hours worked remained flat and the all-important average hourly earnings also stayed flat, undermining the robustness of the headline figure. The U.S. dollar and U.S. bond markets initially performed as expected as the DOLLAR strengthened and bond yields rose in response to positive news. However, by day’s end the DOLLAR was LOWER and the yields on the long end of the CURVE had also dropped while the SPOOS and DOW failed to hold gains on what was a very strong employment picture. The reason given by analysts was that the Ukraine situation was becoming more volatile and caused investors to be cautious over the weekend.
I POSE THIS QUESTION: If the Ukraine/Russia geopolitical news was unnerving the market, WHY DID THE EURO CURRENCY RALLY? Europe has far greater exposure to Russia and the blowback should negatively impact European energy companies and banks with large loan exposure to the Russian economy. WHAT HAPPENED TO THE SAFE HAVEN STATUS OF THE U.S. DOLLAR? The movement of the dollar on Friday seemed to me to be more about the softness in the underlying data rather than the Ukraine.
The potential problem with this analysis was the drop in the 2/10 yield curve, which closed at a new low for the last five months, 216.5 basis points. Although far from being flat, if the bond market was worried about the FOMC erring on the side of keeping rates ultra-low until there was some sign of wage inflation the YIELD CURVES OUGHT TO STEEPEN. The steepening would be an indication that there was a lack of confidence in Chair Yellen and as of now that scenario doesn’t exist. The LONG END of the curve is one giant conundrum. Does it smell an economic slowdown or are the SHORTS still being squeezed? And the U.S. Treasury curve may be being supported by the continued rally in European peripheral debt. The market will soon provide the answer.
In tomorrow’s FT there is an article titled, “IMF’s Jose Vinals Warns on Eurozone Bond Market.” (Mr. Vinals is the director of the IMF‘s Monetary and Capital Markets Department.) He notes that the peripheral bond markets are behaving in a manner that Fed Governor Jeremy Stein has warned about. “We are seeing a lot of what I would call ‘pricing to perfection’ in financial markets, by which I mean pricing outcomes which are really quite good. There is a danger that if outcomes are not perfect, there is room for disappointment.” It seems that one area of disappointment will be the FED raising rates and driving the spreads between U.S. and European debt wider. It is rare that I concur with the IMF, but in this instance I believe Vinals is on target.
***Something to ponder. The Ukraine-Russia situation is not going to calm any time soon for there is much at stake for Mr. Putin. This situation has been simmering for many years. The Russians believe that the U.S. and NATO have been duplicitous in their treatment of Russia and agreements that were made going back to the early 1990s and maybe even earlier. Russian President Gorbachev asked for assurances from the U.S., France, Germany and Britain on the issue of eastward expansion of NATO if the Soviet Union collapsed. To allow for Russia’s acquiescence to German unification it was promised that the Russian sphere of influence would be respected. In a Der Spiegel piece from November 26, 2009, the issue arises about what German foreign minister Hans-Dietrich Genscher promised to the USSR and foreign minister Eduard Shevardnadze. Genscher is reported to have told Shevardnadze: “We are aware that NATO membership for a unified Germany raises complicated questions.”
However, for us one thing is certain. NATO will not expand to the east. Also, on February 10, 1990 Genscher said in a policy speech in Tutzing: “… there would not be an expansion of NATO territory to the East, in other words, closer to the borders of the Soviet Union.” Mr. Gorbachev also maintains that these promises were made to him in the four-plus-two meetings by Secretary James Baker, Francois Mitterand and Helmut Kohl. Vladimir Putin was certainly aware of the promises and although Russia has been too weak to prevent continued eastern expansion of the EU, it seems that Georgia and now the Ukraine were just too close to home.
The west may apply sanctions in the hope of preventing Russian aggression but the stakes may have gotten to high for the Russians to remain complacent. Putin will push to see how deeply the Obama White House and Chancellor Merkel will wish to get involved in actual intervention. Again, Russia has much at stake and has short supply lines. This geopolitical tension will not ease anytime soon.