Everyone and their mother is going to opine on the jobs data this morning, so I might as well offer my quick thoughts. We will have some more action oriented stuff later. Ok, here I go:
Good news for the U.S. economy appears to be good news for the U.S. stock market as S&P futures are up (as I write) on the heels of better than expected February jobs data, a revision higher for January, a slight gain in the participation rate and a slight decline in average hour earnings (wage inflation). Today’s report coupled with last week’s stronger than expected inflation data and strong durable goods put U.S. recession talk on the back-burner, and raises the likelihood that the U.S. Fed will be more hawkish (in tone) at their upcoming FOMC meeting on March 16th. Still, Fed Futures are only pricing an 8% chance of a quarter point hike at that meeting.
There are many smart market commentators saying that this is the best possible set up for the Fed into their March meeting. A surge in wage inflation would have called their bluff on previously stated intention to tighten when inflation neared their 2% annual target and unemployment rate was below 5%.
It’s been my view for some time that the sources of the next U.S. recession are unlikely to come from domestic factors, and is much more likely to come from offshore. And while U.S. stocks breathe a sigh of relief, there still does not appear to be any fundamental improvement in the sources of volatility over the last year. What has changed is fear abating somewhat in commodities and credit.
Larry McDonald, the Head of U.S. Strategy at Societe Generale Tweeted the following this morning:
ECB, PBOC, FOMC Fire Hose =
Since Feb 11
S&P 500: 1810 to 1993 or 10.1%
VIX: 22 to 16
CDX IG: 124 to 96bps
CDX HY: 600 to 481bps
— Lawrence McDonald (@Convertbond) March 4, 2016
Larry’s focus on credit like CDS indices (investment grade and high yield) is worth watching as opposed to spot VIX or the volatility on oil, the OVX. You might want to start watching The Markit CDX North America Investment Grade Index (composed of 125 equally weighted credit default swaps on investment grade entities) which just retreated from nearly 4 year highs, levels not sees since the European Sovereign debt crisis in 2012:
If you were to see investment grade CDX index move back above 120, there is a strong likelihood that the S&P 500 (SPX) is back below 1800 shortly thereafter, and then you all know where I think it goes from there:
And OMG, look at this on a 5 year basis, we could very likely be at a massive inflection point:
So why would the warnings sign start flashing again? From stronger U.S. data, strengthening the dollar on higher rate expectations, despite a stagnant global economy forcing lower rates the world over, and even negative rates. In that scenario the Fed’s divergent monetary policy could exacerbate economic strains overseas, especially in emerging markets which need higher commodity prices.
A strong U.S. economy is more than welcome after 7 years of massive QE and ZIRP, even a fragile one. But it makes me less sanguine about global growth given what is likely to be the continued strength in the U.S. dollar. And in many ways that disparity in growth is the very thing that brings volatility back to our shores, as it is the root cause of recent contagion pressures in commodities, currencies and credit.