Thoughts on the aftermath

Although the earnings data was solid and the unemployment rate reached its lowest level since November of 2007, the focus on Friday's data was unquestionably upon the poor headline payroll figure.  Small wonder, too: it was the third-largest miss since the beginning of 2010 and the first time that payrolls have disappointed vs the consensus for three consecutive months in more than five years.

Beyond that, the absolute level of the data was poor.   To be sure, it was impacted by the Verizon strike that will offer some give back in the future, but even without it the number would have been a stinker.   With it, it was the worst non-census influenced monthly headline figure since February of 2010.

The market reaction was as predictable as it was tiresome.  Fixed income rallied hard, with market pricing of a tightening by July getting eviscerated.  The cumulative probability of a hike dropped from 66% to 30%.

It was carnage chez DXY as well, with nascent dollar longs treated to a lengthy consultation at Dr. Market's proctology clinic.  As noted on Friday, the move in USD/JPY appears to be largely in keeping with the fundamentals.  Although the MXN was clearly a laggard, it still appreciated on the day, which isn't what you'd expect if there were truly a US growth scare.  Indeed, the loony (equally vulnerable to weak US growth) was one of the star performers of the day.

On a strategic basis, the DXY has put in three overlapping waves from the highs on the monthly chart, which Ellioticians could label an A-B-C.   Given last month's bullish candle, the implication would naturally follow that the dollar should bat on and register further gains.   Obviously, last Friday's price action out the cat amongst the pigeons when it comes to that theory.

The zillion dollar question (for today at least) is whether Yellen will execute another handbrake turn to pivot uber dovish once again or whether she'll echo the message of the April minutes and keep her options open.  To be sure, the last two Fed governors to speak- Powell and Brainerd- sounded like they were in no rush to adjust policy.  Of course, by virtue of sitting at the head of the table Yellen has a special responsibility to provide a more holistic message rather than simply expressing a personal view.

What should she do?  Well, an obvious suggestion would be "don't panic".  After all, despite the recent payroll disappointments, the cumulative positive surprise since the beginning on 2013 has been solidly positive.   If the Fed hasn't reacted to the upside surprises (if they had, rates would be quite a bit higher than they are now) should they really react at the first whiff of downside surprise?

Insofar as Fed rhetoric helps to shape economic expectations, the seemingly perennial focus on the downside does the economy few favors.  Yes, risk management is an important part of the Fed's job, but the seemingly constant Debbie Downer message of the last few years is reminiscent of a doctor who tells each patient that every ailment is potentially terminal.

In reality, things have moved closer to the Fed's mandate, even over the past few months.   If we think of policy targets of 5% for the unemployment rate and 2% for core PCE inflation, then measuring the ratio of these two can provide a simple gauge of the distance from the ideal economic settings (a ratio of 2.5.)  As you can see, the ratio has fallen sharply, even over the past few months, and now currently rests at 2.95.  By way of comparison, the average ratio for 1995-99 (seen as such economic halcyon days that Hillary Clinton is trotting out Bill with a promise to "recapture the magic") was 3.06.

And of course, there's the fact that despite the poor data on Friday, US equity indices were only slightly down (still close to the highs in the case of the SPX) and VIX actually went down.   Yes, it was a Friday, but would the latter be the case if the market were really worried by that figure?  Or is it a case of the market expecting its favourite lapdog to roll over when ordered yet again?

One thing is clear, however; since the Fed began to dial back its QE program, there has never been so little tightening priced in with vol this low.

Now, sceptics and/or owners of several hundred billion dollars' worth of bonds might well point to the non-manufacturing ISM is a source of disquiet and a reason for Yellen to capitulate for what seems like the umpteenth time.  And perhaps they are right.  But from a financial stability perspective, equities taking a "heads I win/tails you lose" approach to economic data, at the highs, with P/E's above historic norms, doesn't strike your author as a scenario that is likely to end well, particularly if policymakers are deemed to be at the beck and call of the market.

And so, squaring the circle, while it may seem odds on the Yellen capitulates today, there must be a nonzero chance that she plays a straight bat and keeps her options open.  After all, what's the point of closing the door?  As such, if the reading of the DXY chart above is correct, then Friday's weakness represents a gilt-edged buying opportunity.  The short term set-up in USD/CAD, for example, looks rather tidy and offers decent risk/reward with a stop below 1.29.

Or perhaps just bow to the inevitable and sell cable, as there is a palpable feeling that there is going to be a proper Brexit scare coming soon, what with the polls continuing to show resilience if not strengthening in the Leave camp as the mud starts flying thick and fast.  Sadly, it may just be an hors d'oeuvre to the plat principal of ordure set to be offered up on the American political stage in the coming months...