The playbook for the new week should have been simple enough.
US payrolls are on deck, and with the Fed widely expected to accelerate the pace of the taper in order to “get clear of it” and pave the way for liftoff, too much good news on the data front could be bad news for markets to the extent it argues for policy urgency.
Consensus is looking for 500,000 on the headline NFP print (figure below), a solid encore from October’s “Goldilocks” report.
Wage growth needs to be warm enough to suggest consumption won’t be hampered by inflation, and but no so hot as to suggest a wage-price spiral is in the offing. Simple enough.
“Our initial take was that December would be a placeholder on a number of levels, not least of which being for the macro outlook as well as monetary policy expectations,” BMO’s Ian Lyngen and Ben Jeffery wrote, prior to the Thanksgiving holiday in the US. “Jerome Powell’s nomination is the Administration’s endorsement of the Fed’s recent less-dovish stance and thereby serves to further reinforce the curve flattening trend that we continue to struggle to find any compelling reason to fade, especially as the balance of risks appears to be tilted toward yet another incremental step down the hawkish path — at least for the time being,” they added.
Now, though, all bets are off. The emergence of the Omicron variant and Black Friday’s panic selloff forced traders to scrap the playbook. Bonds staged the most dramatic rally of the year headed into the weekend, and money markets trimmed rate hike bets as stunned market participants pondered the prospect of renewed border closures and travel restrictions. The flattening trend could be jeopardized by positioning shakeouts, although it’s very difficult to say, with any degree of certainty, how the nominal curve might “settle” if things take a real turn for the worst.
The 5s30s reached 70bps Friday, nine basis points wider than the Wednesday tights. Eventually, if the virus were to plunge the world back into recession, the market would price out rate hikes altogether, and the long-end would be caught between expectations for slower growth (bull flattener, all else equal) and a Fed that’s forced to pivot back dovish despite elevated inflation (bear steepener, all else equal). Five-year yields, you’re reminded, dove 18bps Friday.
For now, strategists seem reluctant to suggest that policymakers will be deterred from their nascent hawkish lean. “With the likes of the Fed and Bank of England already behind the curve, it’s unlikely that the new variant will change their direction of travel at this stage,” one PM told Bloomberg.
That’s probably true. But depending on the (figurative and literal) evolution of the virus, the best laid plans could be upended entirely by the end of the year.
If nothing else, Fed officials are likely already reconsidering whether the December meeting is the right time to announce a doubling of the taper pace. Powell would be risking a re-run of December 2018, when “auto-pilot” collided with a government shutdown to trigger the worst December rout for US equities since the Great Depression (figure below).
As a reminder, Goldman and Deutsche Bank, among others, now expect the Fed to announce a doubling of the taper pace at next month’s meeting. It’s not a stretch to suggest those calls could be altered between now and then depending on news flow around the new variant.
Across the pond, investors predisposed to ignoring COVID emergencies in some European nations and the possibility of lockdowns or a technical recession in Germany, can no longer afford to pretend all’s well.
Also on the docket stateside this week, home prices, consumer confidence, ISM manufacturing and services, and a veritable parade of Fed speakers, who will once again be forced to don their virologist hats and explain to market participants what kind of conditions would compel them to reverse course on an accelerated taper plan they haven’t even announced yet.
Could we see a reflexive bounce on Monday? Was the major down move on Friday a result of the humans not minding their algobots? Or is the variant concern leading to a meaningful (5+%) down move?
That’s what I’m pondering at the moment.
And how soon will dip buyers start accumulating cyclicals on weakness in anticipation of New Vaccine Headline 2.0 ?
Great article that left me with similar thoughts, but one thing to keep in mind is that the reduced liquidity during the holiday/short session also meant that price action may have less bearing long-term than it would otherwise, i.e. if it were to occur during a regular session. With liquidity likely returning next week AND the above macro headlines, we might begin to see less correlated behavior across equities (unlike friday, where equities across sectors decided to seppuku simultaneously, excluding a handful with positive cashflows during lockdowns).
Simultaneously, the lack of concrete data increases the possibility of reflexive bounces in several sectors. (putting on my virologist cap) The Omicron data that precipitated friday’s selloff generalized an n=100 sample size across a handful of discrete points in time. General data, particularly on vaccine efficacy will not come out for another several days, although data on international travelers seems to indicate vaccination still works towards preventing hospitalization and symptom severity, but not effectively against carrying the virus.
In this case, transmissibility can likely be slowed with existing measures and will not necessitate a lockdown in most developed nations, i.e. cash flows will continue to grow and valuations will continue to exist at their levels, fundamentals notwithstanding. Yet, while this discounts the possibility of a March 2020-esque crash, this does NOT discount the possibility of a correction across hypervalued (read: indices) equities which may VERY well be triggered by macro data indicating hawkish CB actions (no YCC, good job data indicating rollback of measures, yada yada, etc.). Might be opportunities in selling risk/vol but unfortunately… more data is needed before anyone can reach concrete conclusions.
Great article as always!
The prudent risk management move by the fed is to wait now to see how the variant shakes out. That is a one meeting delay. They can stick to the original plan now. Is it going to kill them to wait to accelerate the taper? Nope. Sorry Mr el ‘erian’.. you are in error now.
@RIA agreed, and again we see the perils of policy by pompous punditry. Were they placed in Powell’s position of profound responsibility with partial information, the ElErians and Summers would be hedging their bets just as he has been.