On Payrolls, Do Investors Fear A 1994 Redux?

Via Steven Englander of Citi,

The median Bloomberg expectation for NFP is 153k, Citi is at 140k; the central tendency of the forecasts is about 125-185k. Among forecasts that have changed today (presumably because of ADP) the median is 180k.  Not everyone shades forecasts because of ADP (especially given its relatively poor forecasting track record) but it seems possible that the true market forecast has shifted up somewhat, maybe to around 160k..

Before the Minutes were released, there was little anticipation or discussion on payrolls. Now that the Minutes are out and have raised market fears that the fed will pull back from ease earlier than anticipated, investors are worried about a repeat of 1994, when a surprise Fed tightening after a long period of easy money (by standards of those days) devastated fixed income markets. Then 10yr Treasury yields rose 170bps over a two month period.

In that light, you have to respect bond market skittishness, whenever 10yr Treasury yields go up by 21bps over three business days. We are not convinced this is what the Fed intended to convey. With fiscal tightening taking 1%+ off US GDP growth in 2013 and mortgage spreads versus Treasuries wider than the Fed hoped for, monetary conditions may not be as easy relative to underlying domestic demand as the Fed intended.

However, you have to respect the market response. And if payrolls come anywhere near close to a 200k handle we will very likely see further a further equity and fixed income sell off. So there is the possibility that we will have a much more exciting morning after payrolls than anyone had anticipated. With investors having started the year buying risk hand over fist, any sign that the Fed is less than forthcoming will likely lead to position cutting. As much as we have liked the risk trade, fear of Fed tightening would likely reverse the trade at least temporarily.

Levels to watch – even with some upward revision to expectations, above 180k would be well above the last three months and viewed as being above trend. Above 200k would bring back the optimism of early 2012, but probably lead to major asset market setbacks, with rate fears dominating stronger activity.

On the weak side 130k would now be viewed as disappointing, barely at trend and showing little change from the prior three months. That might re-establish the expectation that ease is likely to be persistent.

Given the Fed’s use of the unemployment rate as a threshold indicator (even as they insist that they will not use it mindlessly and independent of participation rates), a drop to 7.6% will stoke even more fears of impending tightening.  The consensus is almost even divided between 7.7% and an uptick to 7.8%, with 7.6% a tiny minority, so the pain side is still lower, rather than higher, unemployment.

In currency terms JPY is vulnerable as US yields approach the critical 2% level. However risk correlated currencies in both G10 and EM stand to lose if there is a sharp adjustment downward in the expectation of liquidity provision. So even if US fixed income investors face the prospects of severe losses on their holdings, the prospect of US hikes should be worrisome enough to lead to cutting of short USD positions. 


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