Friday’s unemployment report was on the strong side, although certainly not much stronger than market consensus. Yes, nonfarm payrolls were on the high-end but average hourly earnings were right on target, hours worked remained the same at 34.5 and the unemployment rate dropped to 4.3%, but that could be due to a slight rounding error. The markets traded as if the FED could possibly raise rates in September, but I believe the jobs report provides the impetus for the FED to commence with QT. The U.S. yield curves reacted in such a manner as the 2/10 curve actually rose 3.5 basis points, closing at 91.5.
The analysis is this: If the FOMC were to actually embark on QT the long end of the curve OUGHT to rise relative to the short-end as the FED will not raise the fed funds until they monitor the impact of the QT on various asset classes and the economic data. While the CURVE should steepen, the ECB and BOJ‘s aggressive action may prevent a significant move. The U.S. 2/10 and 5/30 curves have been locked in a 20 basis point-range for several months so any long-term position should only be taken when the range becomes violated on a closing price. The 5/30 range top is its 200-day moving average (111.1), so this becomes a good trade level.
In a query from Pierre to Thursday’s BLOG POST I discussed the ECB‘s QE mechanism of a fresh 60 billion euros to purchase assets has the ability to impact global bond markets. When U.S. Treasury yields rose during the post-nonfarm payrolls trade in response to the “strong” data, European yields also rose a touch. It seems as though the ECB didn’t want to waste its firepower while U.S. yields rose and the dollar staged a strong rally.
GOLD, SILVER and commodity currencies also reacted negatively to the jobs numbers. But after the recent sustained rallies of both the EURO and GOLD a correction was not out of the realm of possibility. (Historical note: Last week’s high in the cash euro currency was equivalent to the price of the EURO at its official launch in January 1999.) But as sharp as the dollar rally was on Friday, the EURO still closed HIGHER on the week but the DXC did put in a reversal week reflecting so much of the divergence that continues to impact traditional momentum-type trading systems.
In Friday’s Financial Times, there was an analysis piece by Mehreen Khan — titled, “Maturing Bond Flows Are Europe’s `Silent Stimulus'” — that builds upon the thesis I have presented: The major impact of the ECB’s QE program. The ECB has been reinvesting the proceeds from the maturing instruments on its balance sheet of 4.2 trillion euros since March. As more bonds mature the “… reinvestment flows will top 120 billion euros next year, according to an estimate from Nordea, the Nordic bank.” The article points out that the ECB has not been forthcoming in exactly how they plan to reinvest the maturing debt and plan to remain flexible in order to meet the needs of the EU financial system. Going forward, the problem for the ECB is going to be remaining within the constraints of its capital key where it has to purchase debt on the percentage of each countries contribution to the ECB capital base according to GDP levels within the EU.
The lack of German bunds will be problematic, especially for financial markets as the German sovereign instruments are highly desired in the repo markets where high quality liquid assets, or HQLA, are the preferred collateral for lenders. The article concludes with this: “Investors will do well to take heed of Mr. Draghi’s assurances that an exit from emergency-era stimulus measures will be steady and gradual. As in the U.S., monetary stimulus in the eurozone will resonate for markets beyond the formal end of QE.” This is a market dynamic that we have to keep in mind as we move into conversations of Quantitative Tightening. In this regard I do not make much of Draghi’s upcoming Jackson Hole speech.
The recent strength in the EURO currency is beneficial for Germany but the still-struggling peripheral economies will not desire an appreciating currency and the stronger EURO will put further downward pressure on inflation. The power of central bank liquidity injections is a powerful market force and keeps the risk parity trade steady as it goes. The FED, ECB, BOJ and BOE keeps the low vol environment intact. We’re waiting for the impact of the FED’s QT to see if anything were to change. But the WHRRRRRR of the printing presses drowns out the noise of economic data: even unemployment data.