For those of you who slept in today, financial markets are enthused by this morning’s May Payrolls Report. Nonfarm Payrolls increased by 559,000, which missed a consensus estimate of 675,000 and “whisper numbers” as high as 1 million. The unemployment rate dipped to 5.8% from 6.1% and vs. 5.9% expectations and average hourly earnings rose by 2% ahead of a 1.6% expectation. The numbers showed that the labor market is continuing to recover, but not at a rate fast enough to spook the Federal Reserve. This is what we call a Goldilocks number – not too hot, not too cold. Just right.
For better or worse, markets and the Federal Reserve are joined at the hip. It’s been quite clear for at least a decade that monetary accommodation is perhaps the key driver of markets overall, and the stock market specifically. Equity futures rallied almost immediately after the release, which led me to make a snarky but accurate tweet about traders’ addiction to Fed liquidity. When it comes to economic outlooks, however, I tend to trust bond traders more than my equity brethren. Stock traders get consumed in stories (and memes) and second order effects like earnings, while bond traders – particularly those who specialize in government bonds and money market instruments – have a largely undiluted focus on the economy and inflationary expectations. They share the enthusiasm.
Rather than unspooling a long narrative about today’s goings on, I’ll let some charts do most of the talking. Let’s start with a look at how the yield curve changed overnight:
US Treasury Actives Yield Curve, Today (green,upper) vs. Yesterday (orange,upper) with One-Day Change in Basis Points (lower)
The lower part of the graph tells the real story. We see yields falling from the 2 year portion through the 30 years. Stock traders used the 5 basis point drop in 10 year yields as a rationale to move into large cap technology shares, pushing the NASDAQ 100 Index (NDX) up over 1.5%. Yet the 1 basis point drop in 2 year notes may be as significant if not more. It implies that even bond traders were focused more on the “Goldilocks” nature of today’s number holding back the timing of a potential rate increase rather than the inflationary implications of higher than expected wages.
The next chart shows that equity markets became more sanguine about future volatility:
VIX Futures Curve, Today (green), Yesterday (orange), One Month (blue)
While VIX traders have been pricing in greater volatility to come in the months ahead, they expect the overall volatility to be much lower than they did a month or even a day ago. It makes sense to see spot VIX fall in the aftermath of a key economic release – an event that could induce volatility is now in the past – but the roughly parallel shift in the VIX futures curve shows that traders are expecting lower volatility in the months to come as well. The steepness into autumn is normal because traders continue look ahead to the key Jackson Hole conference in late August and seasonal worries that often appear in September or October, but the early portion of the summer is now showing expectations of relatively low volatility.
The final chart shows the relative movements in gold (using the GLD ETF as a proxy) and the US Dollar Index (DXY) over the past month. Pay specific attention to today’s movements:
One Month Chart of DXY (blue/white) vs. GLD (red)
Today has been a good day for gold after a brief dip, while the dollar reversed its recent gains. It is not at all surprising to see the dollar fall along with yields, and it is also not unusual to see gold move inversely to the dollar. While gold has spent much of the year acting as an “anti-dollar” rather than an inflation hedge, today’s numbers gave gold traders the opportunity to buy the commodity using either the weaker dollar or greater labor inflation as a rationale.
I know several people who don’t love the Goldilocks analogy. In the end of the story, Goldilocks is either chased away or eaten by bears. Bullish investors are not eager to think about the potential for angry bears changing a happy narrative. For now though, they can sleep in a bed that is “just right”.
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