In Its Latest Nonfarm Payroll Mea Culpa, Goldman Stumbles On THE Answer... And Changes The Rules Of The Game
One has to read very carefully and all the way through the latest Jan Hatzius NFP post-mortem, to catch what may be the most important piece of information Goldman has ever telegraphed to clients, and thus, to the Fed. But first, why the note? As a reminder, after predicting correctly just what the impact of the record warm weather would be on today's NFP print (recall "Is A Bad NFP Print Days Away - Goldman Says Warm Weather Added 70,000-100,000 Jobs; Now It's Payback Time", something Zero Hedge warned first 2 months prior in "Is It The Weather, Stupid? David Rosenberg On What "April In January" Means For Seasonal Adjustments", but that's beside the point) yesterday Goldman was kind enough to tell us precisely what to expect when it hiked its NFP forecast from 175,000 to 200,000 ("If Goldman's recent predictive track record is any indication, tomorrow's NFP will be a disaster.") Of course, betting against Goldman's clients continues to be the winningest trade of the year, if not the millennium.
But that's not the point. Neither is Goldman's attempt to mollify what little muppets are left following its latest faux pas ("we believe that the underlying trend in payroll employment growth is around 175,000 as of the March report"), or to once again shift its focus to a bearish one having flip flopped worse than Dennis Gartman in recent weeks (see The Muppets Are Confused How Goldman Is Both Bullish And Bearish On Stocks At The Same Time) after saying that "we would expect the headline number for April to fall short of this figure, partly because the weather payback is likely to be substantially larger in April than in March and partly because the underlying trend may be decelerating slightly." Nor is the point that Goldman once again attempts to handicap the next latest and greatest New iPad, pardon, New QE. What's the point - QE is inevitable, and it will happen. But at a time that Obama deems appropriate - the one overriding consideration this year is to boost Obama's popularity into the election by any means possible, with structural inflation and employment taking a back seat.
No, all of these are secondary items. Here is what is of absolutely critical importance in the just released Goldman letter, nested deep in Hatzius' final paragraph, where it would otherwise be missed by most:
...we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yields...
For those who are aware of the Fed's sentiment vis-a-vis the debate of stock vs flow of money effect, this will be a stunning revelation. Especially since it vindicates what we have been saying since day one, namely that when it comes to securities price formation in a centrally-planned regime, it is flow not stock that matters. And as those who follow the Fed's thinking know too well, the Fed is convinced it is stock, not flow that serves as a consistent catalyst for subjective risk valuation. The above quote is just the first crack in the Fed's thinking, because if Goldman now believes this, so will Bill Dudley, following his next meeting with Jan Hatzius at the Pound and Pence, and shortly thereafter, it will become canon at the Fed.
One way of visualizing what this means is to think of a shark which has to be constantly in motion in order to survive. Well, the allegory of Jaws can be applied to liquidity addicted capital markets. Translated simply, it means that it is irrelevant if the Fed's balance sheet is $1 million, $1 trillion or $1,000 quadrillion. A primacy of flow over stock means that UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!
We don't have sufficient time to go into the nuances of what this revolutionary run-on sentence means on this good Friday, suffice to say that it makes virtually all the literature on modern monetary theory (in practice of course, the theoretical part is such gibberish that only fans of MMT and Neo-Keynesianism care about it - something nobody actually in the market gives a rat's ass about) obsolete. It also means that absent "flow" or instantaneous Fed monetization engagement at any given moment, risk will collapse, regardless of the actual size of the Fed's balance sheet (which of course has other structural limitations). What is most critical is that this one statement from Hatzius sows the seeds of doubt, and provides a decoupling between prevalent risk prices, and explicit levels of historical Fed monetization. Because what the ascendancy of the flow model means is that unless the Fed is willing to telegraph that it will monetize devaluing assets in perpetuity, thus providing the "flow", the Fed is assured at failing at its only real mandate: keeping the Russell 2000 pumped up.
And while the Fed may be happy to sacrifice its balance sheet at the altar of Dow 36,000 just to preserve the Wealth Effect fallacy, the other counterliability, the US Treasury stock, which by implication will have to rise as it will be the security monetized the most to keep the deficit funded, may not be quite as pliable, and eager to rise parabolically, especially in a time when more and more question the reserve status of the USD, when faced with the ascendancy of the CNY.
Finally, the market still having a trace of discounting left in it, will become quite aware of all these considerations and deliberations, and will promptly demand a practical application of the "flow" model. Which also means that absent constant, ongoing monetization, either sterilized or not (although as we pointed out earlier this week, the opportunity for ongoing sterilization by the Fed is now almost finished as it will have just 3 months of short-end bonds left to sell past June), stocks will crash.
Unwittingly, Goldman may have just resorted to the nuclear option to force the Fed to engage in monetization much faster than it would have otherwise done so, by diametrically changing how Goldman, the Fed, and thus the market perceives Fed intervention.
Or maybe it was all too "wittingly"...
Full Jan Hatzius note:
US Views : Payback (Hatzius)
1. The March employment report was a disappointment. Although the unemployment rate fell, this was due to a drop in the labor force as household employment gave back some of its prior big increases. More importantly, the job gain in the establishment survey of just 120,000 fell well short of anyone's estimate. The big question is how much of the slowdown from February’s 240,000 gain was due to special factors, including “payback” for the unseasonably warm winter, and how much reflects weakness in the underlying trend.
2. We do think the warm weather has been an important driver of stronger payroll numbers over the past few months. As we have shown, all of the acceleration in nonfarm payrolls since the fall has occurred in the (normally) cold states, and our state-by-state panel analysis suggests that weather has boosted February’s level of payrolls by 100k or a bit more (see “Payroll Payback?” US Economics Analyst, 12/14, April 5, 2012). This state-level model suggests that none of the inevitable payback for this boost should have occurred yet, since March was just as warm relative to the seasonal norm as February. That said, weather-sensitive sectors such as mining and building construction did show some weakness, so we would pencil in 10k-20k for weather “payback” in March.
3. In addition, the 37,000 drop in retail employment was partly related to one-off job reductions in the department store industry, and should probably not be included in an estimate of the underlying employment trend. Taken together, we believe that the underlying trend in payroll employment growth is around 175,000 as of the March report. At this point, we would expect the headline number for April to fall short of this figure, partly because the weather payback is likely to be substantially larger in April than in March and partly because the underlying trend may be decelerating slightly (as suggested, e.g., by the drop in temporary help services employment in March).
4. Largely because of the weakness in the employment report, our standard metrics for evaluating the US data flow have also started to send a less upbeat message. Our current activity indicator (CAI), which summarizes all of the key monthly and weekly activity data, is showing a preliminary 2.5% for March, down from 3.5% in February. Likewise, our US-MAP, which compares the data with the Bloomberg consensus, has averaged negative readings since late February, after six months of positive surprises. All this reinforces our view that the discrepancies in the US economic data will be resolved mainly via deceleration in the job market indicators rather than acceleration in GDP.
5. We admit to being puzzled by the twists and turns in Fed communications over the past few months. On January 25, Chairman Bernanke said that under the FOMC’s projections, he saw a “very strong case” for finding “additional tools” to support economic expansion. But in the March 13 minutes, only “a couple” (i.e., two) of the committee’s ten voting members—a number so small that it probably does not include the chairman, whose position makes it unlikely that he would be in such a small minority—thought that additional stimulus could become necessary, and even that only “if the economy lost momentum” or inflation looked likely to undershoot. All this would make perfect sense if there had been a sharp upgrade of the committee’s central forecast over the past few months. But the minutes also said that “…the economic outlook, while a bit stronger overall, was broadly similar to that at the time of their January meeting.” And Chairman Bernanke, in particular, last week went out of his way to cast doubt on the not on that the stronger jobs data through February were indicative of a sharp pickup in growth. Our conclusion is that there has been a shift in the Fed's reaction function back to the hawkish side, and there may be a bit more complacency about the risks to the outlook than suggested by the committee’s decision to retain the assessment of “significant downside risks” in the March 13 statement.
6. So what can we expect from the Fed? Easing at the April 24-25 meeting looks highly unlikely, although the tone of the statement and the Chairman’s press conference may take a fresh turn toward the dovish side. Easing at the June 19-20 meeting, in contrast, still looks more likely than not, at least under our forecast of weaker activity and benign inflation. Our baseline remains a renewed asset purchase program which involves Treasuries and MBS and whose impact on the monetary base is sterilized via reverse repos or term deposits, but it is also possible that the committee would extend Operation Twist; there is approximately another $200 billion available, and it would only take a small reduction in the flow of purchases to make this number last until yearend.
7. Stepping back from the tactics, we still see a strong fundamental case for following up Operation Twist with a successor program. First, even under its own forecast, the committee expects to be far from fulfilling the employment side of its mandate by 2013-2014, so it is easy to sympathize with Chicago Fed President Evans’s call for more action. Second, growth could well disappoint the committee’s forecasts, given all the usual uncertainties around the weather impact, the inventory cycle, energy prices, and the “fiscal cliff” at the end of 2012. Third, a failure to do more might imply a tightening of conditions, assuming financial markets are still discounting some probability of easing. In addition, we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yields. And fourth, the risk of a material inflation overshoot seems low given the still-large amount of spare capacity, not to mention the Fed’s ability to reverse course and tighten financial conditions substantially via forward guidance, rate hikes, or even asset sales should the need arise.