Financial markets are catching their collective breaths during this holiday week, following last week’s quizzical jobs report. At first read, analysts jumped on the euphoric train that was headed for a Fed hike in December, but, after further analysis, the shadier side of the data has begun to see the light of day. Yes, 5% unemployment is a good figure, but suddenly the recession drums are beating in the distance again. Yes, net job additions exceeded expectations, but they were concentrated in low-paying jobs for citizens over the age of 54. The euphoria on Friday has dissolved and been replaced by confusion.
When confusion presents itself, markets tend to wobble in very tight ranging patterns across the board. When in doubt, stand still, like a squirrel does when it is in the road and spots an oncoming car. It freezes, but, when the car gets near, it gyrates in a frantic dance, hoping to make the right move for survival. This metaphor may be a bit of a stretch, but you can almost sense the stillness that uncertainty brings and the potential for rampant chaos to come.
Like it or not, the Fed has primed the pump, but has yet to hit the ignition switch. Experts are now predicting December or January for a rate hike, which will remove the overhanging cloud of uncertainty. The degree of chaos, however, is up for debate. In the meantime, analysts must look to the heavens, to history, or to their tea leaves to fathom what might happen in the near term. The race to find the magic chart or most revealing picture of arcane data is on, once again. Is there really a needle in this haystack?
What can copper and oil price trends tell us about what might happen?
Economists have always looked to copper as the bellwether of global economic activity. It is one of our better and more reliable leading indicators that signals when commerce is about to pick up. The metal is part of everything from electrical wiring and electronics to machinery of all types. If demand is up in the copper sector, it is because manufacturing and construction are making upswings. Add oil prices, and the previous chart emerges.
Oil prices are on the left axis, while copper prices are on the right. The correlation of their pricing behavior over time is quite remarkable. The horizontal “tan” dotted line represents the average price point of each commodity over a four-decade span. Over such an extended period, however, inflation and the growing prosperity of developing countries have had an effect, although supplies have grown, as well. For these reasons the “blue” dotted line has been added to reflect gradually increasing support levels that hover slightly below current prices in the market.
Much has been written about the deflation spiral that has been affecting global commodity prices for the last four years. The peak that is evident in 2011 was followed by gradual declines. Momentum accelerated in the past eighteen months in search of a bottom level of support for both resources. Have we hit bottom? Whether you accept the tan or the blue line correlations, analysts are now forecasting that at least one of the two levels must be tested by the whims of market traders. Global demographics, easy credit, reckless speculation, and quantitative easing may have been behind the severe price run-ups in the past, but, going forward, basic supply and demand forces must take over.
Why did the jobs report euphoria dissipate?
Although the situation in the commodity sector puts a pall over the global economy, the monthly jobs report is presumed to be the bellwether for subsequent actions by the Fed. The headlines were screaming on Friday: “271,000 net new jobs and unemployment rate down to 5%”. Consensus expectations were low at 184,000, a follow on to September’s low figure, and so it is not that difficult to see why champagne corks were popping.
The change of heart occurred over the weekend after a more sober review.
Two major concerns arose upon further inspection. First, the new job additions were concentrated in the “Over 54” population demographic, a disconcerting fact since the need for jobs at the low end of the spectrum is paramount. Secondly, the nature of these job additions is that they were both part-time and low paying, not exactly focused upon the “breadwinners” of our economy. Our economy is service driven to the tune of 70%. If per capita household income is stagnant, as it has been since 2000, then retail spending for products and services also stagnates, both now and in the near-term future.
The chart above comes courtesy of David Stockman, the economist and budget director of Reagan fame. He has been severely critical of Fed policy directions for some time and minces no words in describing what bothers him: “No, it wasn’t a “blow-out” jobs report. Inside the artificially bloated, trend-cycle adjusted headline number was the same old BLS con job and an economically devastating shortfall where it really counts… Last month’s purportedly “awesome” jobs report contained 1.4 million fewer breadwinner jobs than existed way back in the very first month of this century!”
The unemployment rate of 5% is also disconcerting, since it disguises the true picture of what is transpiring in our society. As one analyst opines, “It excludes discouraged workers, which is anyone that does not currently have a job but has not looked for work in the past four weeks. A more accurate measure of the true employment situation is the labor force participation rate, which tells us what portion of the working age population is either working or is looking for work.”
The Participation Rate also peaked at the millennium at just above 67%. It, too, has been in a steady decline down to October’s 62.4% level. This level represents “a record 94.5 million working age Americans considered to be outside of the labor force.” Many economists attribute this drop to the general retirement of the “Baby Boomer” generation leaving the workforce, but this presumption, although logical, does not explain everything that is happening. The Participation Rate for 25 to 54 year olds has also declined over the same period from 84.7% down to 80.7%, not a good sign for future prosperity.
All in all, the October jobs report was not a cause for celebration. Yes, the headline figures looked impressive, but, in this case, the devil was in the detail. The U.S. economy may be muddling along better than most other developed countries, but it is not generating the necessary demand to fuel a dynamic global recovery. As for the report, it was “only a positive one for those workers that are in the twilight for their careers. For younger workers who are attempting to build their careers and raise families, it was quite disappointing.”
What are the pundits now saying about future Fed directions?
We have now come full circle to re-visit the fundamental theme that is driving global financial markets – central bank policy divergence. The roadmap appears unchanged. The U.S. will take the lead in interest rate policy normalization, as it has been termed. The U.K. will follow, perhaps one or two months later, while the balance of the world is caught up in various quantitative easing programs of some sort. These man-made artificial constraints on market forces have to be unwound or normalized at some point, but many fear the consequences of such moves.
The Fed’s constant message has been that it will be a gradual, long drawn out process. Fed Chair Janet Yellen displayed a concerned level of caution in these recent words, “Policymakers should be mindful of new channels for monetary policy transmission that may have emerged from the intricate economic and financial linkages in our global economy that were revealed by the crisis. It is crucial to understand the effect of regulations and possible changes in financial intermediation on monetary policy implementation and transmission.”
Did that make sense to anyone? It is “Fed Speak” for “I am worried that we do not know what we are doing, and we had better be careful.” She may be paving the way for pointing blame at “unknown unknowns”, the famous excuse concocted by Donald Rumsfeld for his failings some years back in the Defense Department’s abysmal handling of the Iraq War. It is amazing that anyone in Washington understands a thing, after being cloistered in our nation’s capitol, far from the front lines of action.
The debate has now returned to one of timing. December and January are the latest forecasts that garner the most votes among guess-timators. Analysts are, however, growing weary of the process: “Once again, eyes will be glued to monitors, television sets and even radios. Players will parse the Fed’s statement with a fine-toothed comb, hoping to come away with a nugget that will tell them when the long awaited (in some cases, dreaded) hike in interest rates will arrive. If and when they find such a nugget, the markets will undoubtedly conclude that the days of wine and roses are over.” Will this be the moment when money managers, traders and investors change strategies?
Concluding Remarks
Is the economy, both domestic and global combined, strong enough to withstand an increase in Fed interest rates? Economists have been claiming that it has been for some time, despite recent perturbations in China and the commodity markets. As for timing, David Lebovitz, global market strategist JPMorgan (N:JPM) Asset Management, makes a good case for December. “It takes about six to nine months for monetary policy to hit the economy, so I think the Fed by going in December, isn't necessarily too late, but further kicking of the can may put them a little bit behind the curve.”
The Fed skipped a beat in September, passing on a rate hike, presumably at the behest of Wall Street and the IMF. I doubt if Ms. Yellen and her banking buddies will gulp hard a second time around. Even though the impact of such a change has been downplayed in the press, financial markets will still gyrate accordingly, a “perfect storm” of sorts for yearend forex trading. Yes, markets may have baked in some assumption for when a rate hike might take place, but there is no prevailing consensus in the futures markets at present. As December approaches, new surveys will appear. The haze will dissolve, but only to a small degree. Uncertainty will remain, which means opportunity for traders.
It’s time to get your strategies ready. The engines are about to start!
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