The monthly Nonfarm Payrolls report offered a surprise this morning. Payrolls increased by 263,000, well above the 200,000 consensus (and above a “whisper” number of about 188,000). Last month’s report was revised higher by 21,000 as well, though the unemployment rate remained unchanged at an as expected 3.7%. Perhaps most importantly, average hourly earnings accelerated sharply. The month-over-month increase was 0.6%, well above the 0.3% consensus and above last month’s reading, which was revised from 0.4% to 0.5%. The year-over-year rate was 5.1%, which is obviously well above the level targeted by the Federal Reserve.
My initial reaction was this: despite some recent reduction in the JOLTS numbers, at over 10.3 million they remain well above pre-covid highs. We shouldn’t be surprised when companies do their best to fill those openings, and with a low unemployment rate it remains costly to do so.
The initial reactions by stock and bond markets were predictably negative. Two-year yields jumped by as much as 22-basis points and 10-years jumped by about 12. Stock futures plunged, with NQ futures indicating as much as a 2% loss. Since then, both have recovered to more modest losses. As I type this in late morning, 2-year yields are up “only” 11 bp an 10-years up 8bp. The S&P 500 Index (SPX) is down by just over 0.5% and the NASDAQ down by about 1%. It is one thing for markets to recover from an initial overreaction, another to be flirting with a full recovery. (To be fair, the rail strike news is a valid positive.)
In trying to resolve how investors can shrug off inconvenient data when the Fed professes to be data dependent, I searched the term “data dependent” in text of Chair Powell’s to the Brookings Institution that spurred markets earlier this week. Guess what, there’s no mention of it. So, why shouldn’t hopeful investors be able to shrug it off?
One sign of the relative complacency is the sub-20 level of VIX. Although we’ve explained why VIX is not actually a fear gauge, its recent decline to levels near its year’s low does raise some eyebrows. Today’s decline is also likely to reflect that one of the month’s most important data points is now behind us. At this point, it is important to remember that VIX is constructed to measure the market’s best estimate of volatility over the coming 30 days. VIX is telling us that traders expect smooth sailing into year end. When we consider that the last two weeks of the year are typically slow, that is not necessarily wrong-headed. What is interesting is that traders then expect volatility to increase over the coming months, as indicated by the VIX futures curve:
VIX Futures Curve, Today (yellow, top), 1 Week Ago (red, top) with Changes (bottom)
Source: Interactive Brokers
We see that over the past week, there has been a roughly parallel shift lower in the curve. There is a fairly pronounced drop in the date that includes the FOMC meeting (December 14th) and the subsequent weekly expiration (December 21st). Considering the improved consensus about a 50-basis point hike, that too is not surprising. But note the steep contango into January and beyond. This implies quiet for the coming 30 days and then a resumption of volatility thereafter.
It is quite fascinating to see how implied volatility has plunged over the course of a month. Notice how SPY switched from a term structure in sharp backwardation to steep contango. Yet even in the data from a month ago we see a dip in the December portion of the curve. That is the market’s ongoing recognition of seasonality.
SPY Implied Volatility Term Structure, Today (yellow), Yesterday (orange), 1 Month Ago (magenta)
Source: Interactive Brokers
Equity markets are clearly taking the view that the markets will remain stable and healthy into the end of the year. There are certainly a wide range of individual and institutional investors who are rooting for a solid end to a rough year, many of whom are betting on it. If enough investors believe that something will occur, they can indeed make it happen. At least in the short-term.
Disclosure: Interactive Brokers
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