April non-farm payrolls came in 45k below the 205k expectations, with a revision lower for February and March. April’s print was the lowest since September 2015, and the 2016 average of 192k per month is below the 2015 average of 229k.
The knee jerk reaction by traders was to sell equity futures, buy gold and buy U.S. Treasuries. For the moment, bad U.S. economic news is bad for traditional risk-on trades. This was not the case in the age of QE & ZIRP, where it seemed investors were emboldened by poor economic news, resulting in a faith that the U.S. Fed would come up with new creative ways to support risk asset prices. But now it’s a problem at this stage of the game. After the Fed’s first rate increase in 9 years in December, expectations were for the Fed Funds rate to be above 1% by the end of 2016. Fed Fund Futures are now pricing less than a 1% chance of the Fed Funds rate being above 1% at their December 2016 meeting:
The Fed’s about face since December is not bullish for risk assets in my opinion. The U.S. and the global economy were supposed to be demonstrating far better growth, and more importantly, stability after trillions of dollars of monetary stimulus since the financial crisis. And the inability of the U.S. Fed to normalize policy for fear of a redux of what happened in Jan/Feb in global markets should scare the crap out of investors. A sensible exit plan of what was unprecedented crisis monetary policy is not in the offing. We are truly in uncharted territory.
And that leads me back to artificially low interest rates. U.S. stocks had no problem rising with rates back in 2013, as the 10 year Treasury yield got back to 3%, the S&P 500 (SPX) was making new all time highs. Yields tumbling from their 2014 highs, to their early 2015 lows was the final condition needed for a sort of last dash for U.S. stocks (see what Druckenmiller just referred to as TINA), with the SPX topping out in May of 2015:
But since last May, the SPX has had two sharp downward volatility shocks, two lower lows and two lower highs. The path of least resistance, is NO longer higher. This chart isn’t showing consolidation before a new high, it appears to be showing another failure at a lower high. And at a time of a clueless Fed that is more likely closer to easing than they are to tightening:
Remembering that in the height of the volatility in February, the U.S. Fed supposedly asked large financial institutions to consider the possibility of negative interest rates and their effects on their capital positions. This at a time when the ECB and the BOJ’s move to negative interest rates have had the exact opposite of the intended effect on their currencies (causing them to rise) and their stock market (causing them to decline). Some believe that the U.S. Fed will actually move towards yields below the zero interest bound in the event of a growth shock. Remember, for the most part they have exhausted most traditional means of stimulus and as the WSJ’s John Hilsenrath suggested on August 17th, 2015:
So some sort of crisis is coming. A U.S. recession is in the offing at some point likely prior to a full blown crisis. And with with rates where they are, the Fed’s only option is to go from unconventional to just making stuff up.
Which brings me to one last chart, at the last two stock market peaks in 2000 and 2007, the Fed Funds rate was above 5%, offering tremendous wiggle room for the Fed as risk asset prices were in a free fall. The flat white line below suggests that what comes next is anything but traditional.
If the current dip turns into a real correction, it might makes sense to see how risk assets act at the February lows before placing more blind faith in central banks to continue to execute on policies designed to combat a prior crisis.