Strong jobs data turns the pain trade up a bit

Summary

Global markets were positively fazed by May jobs data, though the release turns the dollar’s pain trade a notch higher.

High side of “Symmetric”

Closely watched earnings growth was better than forecast at +0.3% month-to-month, and in-line at 2.7% on the year, suggesting orderly rather than volatile tightening demand for labour. That demand pulled the unemployment rate down by a tenth of a point to 3.8%, more than forecast.  Still, Friday’s jobs data have not perceptibly moved the dial on the question of whether inflation might accelerate fast enough to force a fourth 25 basis-point rate hike this year. That seems to be the key reason why stock markets have kept the risk lever tilted to the ‘on’ position. The “symmetric” quality the Fed introduced to its inflation target at the last meeting is balanced by upside risks—like tax cuts—which have yet to feed through much to the real economy, and downside risks to growth—chiefly an unpredictable impact from deteriorating trade relations.

December hike odds rise

Yet from the perspective of fine tuning risks to equity markets, Friday’s job numbers are not strictly speaking in the positive direction.  Let’s assume 2018’s second hike happens at the June meeting. Fund futures implied a 93.8% probability after Friday’s data, against 90% probability a month ago. The third move higher in the target rate this year is most likely at the FOMC’s September’s 25^th-26^th meeting. That would leave only December’s meeting, when a press conference and economic projections are scheduled, for another ‘normal’ policy change. Market pricing for a move on that day has merely inched up on Friday, to 47.3% implied probability from 47.1% on Thursday, 45.9% a week before and 41.5% a month ago. These odds may not yet be compelling, but they could be soon.

Anticipation

Just as important though is that the readings indicate parts of the market is beginning to position for a possible point in the near term when chances of a fourth hike break above even. On the one hand that should be reassuring with respect to risk, as it would suggest reduced surprise. But after equity market gyrations this year linked directly to Fed rate anxiety, anticipation of a steepening rate path will continue to be a negative for risk-seeking markets. Dollar positioning that has stayed inarguably short, looking at CFTC data, should be ranked amongst possible pain trades that participants are not positioned for as ‘perception risk’ rises. It’s worth noting a comment the new Fed chairman Jerome Powell made recently: "some investors and institutions may not be well positioned for a rise in interest rates, even one that markets broadly anticipate.” As the first outbreaks of dollar-stress appear in emerging markets, carry now more marginal and inflation-adjusted valuations still elevated, Powell’s words may come back to haunt many.