Post-Jobs Update ... And then the Yuan ... 2015 Rate Hikes Now Looking Dubious

The image above reflects my view that Yellen is likely to remain dovish through the remainder of the year, and that the market-implied odds of a 2015 rate hike are too high.

The threat of further strengthening in the USD and its affects on the U.S. economy (i.e. domestic companies’ ability to compete against cheap foreign imports), in addition to the impact it would have on the economies of several emerging markets (who borrowed excessively in the dollar during the Greenspan / Bernanke printing era, when the market was flooded with cheap, U.S. dollars), will likely keep Yellen on the fence in September and probably even December. Liquidity addicts everywhere can’t handle a tightening in the world’s most powerful economy. Add to this China's currency manipulation (from what was once a tightly-controlled currency to one now used to combat weak export sales and take out competition in the export markets) and its painful affects on nearly all countries ex China, after its central bank just implemented two consecutive currency devaluation measures of historic proportion, one day after another. Tuesday's devaluation sent the Yuan for its largest one-day loss relative to the USD in two decades (nearing 1.9%). This has instantly made Chinese goods more competitive with American products, and comes after Chinese export data fell far short of expectations, declining 8.3% YoY versus consensus expectations for a decline of only 0.3%. So while the Chinese government (the PBOC or "People's Bank of China") may claim they're simply changing policy to allow their currency to trade more like a "market-driven currency," the move is quite timely considering the status of the export-driven economy. PBOC assertions aside, here's why they adjusted policy so promptly. They have two primary goals, one being to keep the Chinese economy growing (with employment high), and the other to promote the Chinese currency, the renminbi (or "RMB" or the "Yuan") so it will ultimately be recognized globally among the dominant or "core" currencies and can make its way into the IMF's SDR reserve currency basket, currently occupied by the USD, the EUR, the GBP and the Japanese Yen. On Tuesday, the PBOC thought they'd figured a a way to kill two birds with one stone: by moving the Yuan's pegged rate to the USD at the end of each day in the direction the market had moved it during the day's trading, it was becoming more of a "market-driven" currency (in theory), while simultaneously dropping in value as the government conveniently pegged it low heading into Tuesday's trading and continued the practice by pegging it even lower for Wednesday. After the currency saw a massive decline in Wednesday trading, PBOC officials intervened to prop up the yuan in the last minutes of trading. This was after the yuan had fallen nearly another 2% - the maximum allowed for a single day in mainland China - to its lowest level in four years. In the final minutes of trading, according to the Wall Street Journal (who interviewed people familiar with the matter), the PBOC instructed state-owned banks to sell dollars on its behalf and as a result, the currency bounced back with a 1% reversal of the ~2% lost on the day, for a net loss of just shy of 1% by the close. China's actions do not only affect China or the U.S., but also have major effects on mining-dependent Australia as well as the emerging markets, many of which rely on demand from the country for sale of their consumer goods. The PBOC's monetary actions have a particular impact on the surrounding emerging countries in Southeast Asia, who fear of contagion and stand ready to implement similar actions to remain competitive with China.

The Chinese saga simply adds to the pressure on Yellen to keep policies accommodating. On top of a still stagnant wage picture and current underemployment (based on labor force participation rates and high part-time employment), the global macro backdrop looks quite ominous. Drama out of Europe continues after Greece and its EU creditors finally reached (yet another) bailout deal; Puerto Rico recently announced it simply cannot payoff its creditors; commodity prices from gold to iron ore to crude are at or near five-year lows; Canada and Australia are facing a recession and cutting interest rates; and countries like South Africa have been hiking up borrowing costs. Perhaps all this drama, occurring simultaneously of unprecedented magnitude, is not just the result of normal, private market cycles in the era of globalization ... these issues are symptoms of a more powerful cause. The drama did not create itself, nor was it created in a vacuum. It was created by central banks across the globe, whose excesses have led us to what I like to call the "era of free money." What Yellen recognizes but will face much difficulty fighting is that this "free money solution" is not a solution, it's the cause. So how do we get out of this mess? We've dug ourselves pretty deep, so it's a difficult mission; but if we've learned anything from the past, printing money certainly is not the answer. The only real solution can be to purge all the mal-investments and resource misallocations driven by the era of free money. This will likely result in economic depression on a global scale, but just as heroine addicts must endure the pain associated with detox, we must endure the consequences of irresponsible monetary actions, which become especially harsh when they've been allowed to continue for over 10 years.

In my view, investments that will be first to implode include dollar-denominated sovereign and corporate bonds of certain emerging markets; the equity and debt of certain over-levered frackers and shale players in the U.S.; sovereign bonds of other European countries (ex Greece) such as Spain, Italy, and Portugal; and some ill-advised domestic lenders including private debt players with too much dry powder that was put it to work irresponsibly, as well as some debt-oriented hedge funds who had to choose from overpriced, high-risk distressed investments in public high-yield debt markets which were drastically overpriced or perhaps less risky, yet still overpriced, low coupon debt in private entities in the middle- and upper-middle markets (some of the "shadow banking" players should come under pressure, while others in the shadow banking system, namely those who sat on the sidelines holding cash waiting for a collapse, should thrive). 

I previously posted a "Preview to the July Jobs Report" on My Blog ahead of last Friday's July Jobs report, indicating the key data points to look out for ahead of the print (i.e. those market-moving data points most closely followed by traders and the Fed), primarily headline unemployment (and how it offers a misleading and incomplete picture of labor market conditions), the labor force participation rate, private nonfarm payroll additions and, most importantly, wage growth. The preview offered my expectations for how the July data would look, and how this would translate to short-term Fed Policy decisions (I couldn't leave the liquidity addicts hung out to dry!) We've got to rid the system of its liquidity addiction and hyper-focus on short-term rates, certainly if we ever want to develop a functioning global market that's sustainable over the long-term.

As it turns out, numbers came out in line with my expectations, and my expectations remain unchanged: the Fed will not be raising rates at its September 16-17 FOMC meeting, probably not in 2015 either given broad economic malaise pervasive in the global financial markets.

This can also be found on my blog, but I've posted an update after Friday's print (detailing how I interpret it, insofar as it relates to Fed policy). Now, these are only my views, they differ from many of the news sources, so I'll give you the detail below and let you choose how it's best interpreted.

UPDATE: FRIDAY’s JOBS REPORT vs. MY EXPECTATIONS

A few posts back, on August 7 I provided a summary regarding what to watch for inn Friday’s Jobs Report prior to its release, highlighting the key areas in the report in which the Fed will focus in making monetary considerations and my expectations for how these numbers would look, once released.

1) WAGES

In my preview, I cited “1) WAGES – LIKELY TO REMAIN STAGNANT.” Well, that’s precisely what they did, and have done for some time now.  Average hourly earnings for all employees on nonfarm payrolls rose 5 cents to $24.99, or +0.2%, pretty abysmal.

The chart HERE was compiled using raw wage data from May 2007 to March 2015, from the Bureau of Labor Statistics (www.bls.gov). As you can see, ever since hitting a peak during the Great Financial Crisis (GFC) in December of '08 wage growth went on a rapid slide through June 2010 and has been largely stagnant ever since, despite billions of dollars in asset purchases and bond buying (open market operations) over the period. Money well spent? You decide.

In response to July’s Jobs Report, AFL-CIO Chief Economist Bill Spriggs noted:

“The slowing job growth over the past three months in the private sector coupled with continued flat real wages confirms what we’ve been saying for months – that the economic recovery needs to remain the focus of economic policymakers until we see broadly shared wage growth and a return to a higher share of people working [EM: referring to the labor force participation rate, a topic I’ll discuss later].”

AFL-CIO Senior Economic Policy Advisor added:

“This is a relatively healthy report showing continuing job gains, modest wage gains and no inflationary pressures. However, much more remains to be done regarding both jobs and wages. Meanwhile, Federal Reserve Policymakers must guard against accidentally shooting themselves in the foot by mistakenly raising interest rates to combat phantom future inflation.”

Both of the quotes cited above support my argument that the market’s overpricing in a September rate hike.

2) PAYROLLS

Among the news released in these monthly Jobs reports, Non-Farm payrolls is the most market moving data.

As I anticipated (refer to my previous note before), July Nonfarm Payrolls fell short of expectations. Expected job gains were +223k for the month, but came  in slightly short at +215k. What’s notable is the upward revisions to payrolls figures for the preceding two months, suggesting a declining trajectory for private nonfarm payrolls:

May:  +260k (revised from +254k)
June: +231k (from +223k) – payroll additions down 11.2% from May’s +260k
July: +215k (likely to be revised up, given the prior two months, but I will not speculate on this) – down 6.9% from June’s +231k, and down 17.3% from the +260k gains posted in May

I suspect that although the major news outlets fail to take notice of items like this and instead report primarily on headline figures relative to forecasts, Janet Yellen and other members of the Fed put these numbers under a greater degree of scrutiny and should recognize this trend (at least we’d hope!) . Given the importance of trends and their implications for future economic conditions, a trend such as this (i.e. continuous reductions in payroll additions MoM) would  be a cautionary signal.

3) UNEMPLOYMENT

In my last note, I cited that headline unemployment was unlikely to change drastically MoM, nor was labor force participation or the number of part-time workers who’d prefer to be working full-time. This remains the case, as was detailed in the Jobs Report, with headline unemployment flat MoM at 5.3%, and labor force participation still low at the same level reported in June, 62.6% 

Here’s how I view these figures affecting Fed policy decisions (all directly quoted from my previous note, prior to the release):

“Yellen and fellow FOMC members remain highly focused on removing “slack” from the labor market, and while 5.3% (June) unemployment is reasonably solid it is not great due to some critical factors not considered in headline unemployment: (1) a large number of part time workers who would prefer to be working full-time, and (2) a massive decline in the labor force participation rate. Yellen is aware of these factors and while she may pretend to be overly optimistic on unemployment when she continues to cite headline figures at post FOMC meeting press conferences, she generally will put a brief statement in about concerns regarding the part-time workers and labor force participation, suggesting their is a bit more “slack in the employment market than is depicted solely by headline unemployment.”

I suspect part-time workers and labor force participation won’t change drastically month-to-month between now and September, certainly not enough to warrant a major change in the Fed’s view to prompt an earlier rate hike.

KEY TAKEAWAY: THE FED’s NEXT ACTIONS

Nothing came out of Friday's job report that, by my perception, will catalyze Yellen to pull the trigger in September. Put simply, I think Yellen will continue to be more dovish than the market has priced in, primarily due to other issues discussed in the article's introduction (e.g. problems in Europe; EMs that are highly dependent on a stable or weaker USD due to massive holdings of dollar-denominated debt and a weaker demand environment; Puerto Rico's default; China's move to market manipulation after ugly export data, with the Yuan headed for its largest 2 day loss on record of nearly 4%, before PBOC officials stepped in and took measures to reverse 1% of the day's loss; Canada's entry into recession and QE attempts to combat the sluggish growth, while places like South Africa are hiking up rates; commodities prices on a rapid slide hitting 5 year lows; Australia having serious issues due to its mining-dependent economy).

Now, with China's central bank taking the most major action in its history after the release of extremely weak export data (July exports down 8.9% on the year, versus estimates for a decline of only 0.3%) by devaluing its currency almost 2% against the dollar in a single day (Tuesday), followed by further devaluation Wednesday (today) of roughly 1% against the dollar, the world is looking like an uglier place and the stock markets, well, they aren't so pretty either. 

While I'm of the view that Yellen is unlikely to raise rates at all this year, to avoid being painted as the global villain who hiked rates when everyone else was struggling and implementing QE to handle widespread economic malaise, , her press releases would suggest otherwise as she constantly refers to the Fed's goals of maximum employment and stable inflation as the sole basis for policy making. Somehow I suspect she also understands the global implications that could result from further strengthening in the USD, not to mention this wouldn't serve either of her stated goals: "maximum employment" would be hard to achieve as domestic internationals struggle to compete with cheap foreign goods, both in the import and export markets; and when it comes to the Fed's other role of price stability and inflation, their beloved PCE inflation measure (Personal Consumption Expenditures, excluding food and energy) wouldn't hold up too well when U.S. consumers are buying cheap Chinese product off Amazon rather than domestically-produced goods. In this scenario, it would be under her lead that the U.S. becomes the next Japan, whose central bank (the BoJ) printed masses and masses of Yen but saw very little payoff, and still can't get even close to its target 2% inflation rate.