Notes From Underground

Based on the recent ADP report and other economic data, logic would dictate that Friday’s jobs report OUGHT to be very strong. If the data is weaker than expected, analysts will look to the impact from Hurricane Florence, ” the storm the authorities came to blame.” There are projections that jobs will be diminished by upwards of 50,000 so the initial algo traders will be thwarted. As usual, the critical component of the jobs number will again be the average hourly earnings (AHE), which are expected to rise 0.3% following August’s increase of 0.4%. If this number were to print 0.5% expect bond futures to come under pressure, even on top of violent increase in yields we have experienced this week.

The Powell Fed seems to be very comfortable allowing the markets to guide price movements. The market has to come to accept that regardless of impact to all asset classes “the cavalry is not coming.” This is certainly a dynamic in market psychology. The consensus for the unemployment rate is 3.8% with a gain of 185,000 jobs. Patience will be required for if the data is as expected there will be a relief rally in the interest rate futures, which will affect all asset classes. Do your work and be prepared with your technical support and resistance levels for the reaction will be violent.

***Something to recognize: In September 2017, I noted a very important CHART that I have kept for more than 30 years, a simple ratio of the S&Ps versus U.S. 30-year bonds. I noted that the close of the ratio on that last day of the quarter was the first time that it closed above the all-time high made on December 29, 1999. During the past year, this market indicator has rallied to a new record high of 2118.0 from 1636.8, almost a 30 percent increase in the S&Ps relative to long-term interest rates. To me, this serves as a warning that equity valuations are extended relative to the cost of debt financing.

More importantly, this not junk financing but the borrowing rates for what is deemed one of the highest quality assets in the world. Last year, some readers scoffed at the simplistic nature of this ratio but I have used it at times as an important signalling mechanism. I am aware of its possible implications.

***There was an important news story out of Europe from the MNI wire service. It reported some European and ECB sources were suggesting that the central bank would embark on a U.S.-type operation TWIST program in which the ECB would extend its duration on debt holdings by replacing expiring debt with assets further out on the curve. In addition, the sources claimed that the ECB would make its capital key rules more flexible. I BELIEVE THIS IS NONSENSE although it may have been done to assuage the Italians. BUT THIS WOULD BE A CRITICAL ERROR ON THE PART OF THE ECB. WHY?

To refresh your memory: During the European sovereign debt crisis in 2011-2012, Mario Draghi pledged on July 25, 2012 “to do whatever it takes” to save the European financial structure. At that time, the greatest stress on Italian and other sovereign debt was felt on the short-end of the curve. Two-year yields soared as creditors feared about the ability of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) to fund themselves in the near term. Greece still does not have a very viable two-year sovereign debt instrument.

In response to the story, German debt bore the brunt of the price action as BUND yields climbed almost 6 basis points. This was a logical response if the rumor has credibility. But from my seat it is a an ill-conceived idea until there is a EUROBOND. An Operation Twist worked in the U.S. because it has a unified debt market of great liquidity and credibility. Furthermore, the Germans will HAVE to be the ones acting as the progenitor of such a plan. The rise in U.S. yields is causing the onset of pain to global credit markets. Rumors beget volatility providing the backdrop of massive losses.

Tags: average hourly earnings, ECB, Europe, nonfarm payrolls, operation twist

This entry was posted on October 4, 2018 at 7:17 pm and is filed under data, ECB, United States. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.