You know that US interest rate hike everyone was getting ready for in mid-June? The one that was good news for markets because it showed how strong the US economy was?
It’s off the table. It was dealt a mortal blow on Friday, with the release of the non-farm payrolls employment data for May. To say that it badly missed expectations is an understatement.
The forecast was for a 160,000 gain in jobs for May. Instead, the number came in at just 38,000. Employment gains for April and March were revised down too, meaning around 60,000 less jobs in those months than initially expected.
There were some one-off factors impacting the result, but it was unequivocally disappointing. So you can forget about any interest rate rise for the time being.
Currency markets had a fit when the numbers came out. The US dollar tanked and anything ‘non-dollar’ soared. Gold surged more than 2%, as did the Aussie dollar. The main gold stock index in the US, the HUI, soared 11.5%!
This gives you some idea of the positioning of the market leading into the employment data release. The prospect of a June rate rise saw a lot of bets placed against gold and gold stocks.
But when the data came out on Friday, traders got out of these positions as quickly as possible, forcing a huge rise in gold shares in particular.
Funnily enough, stocks didn’t seem too bothered by the news. The Dow and S&P 500 fell 0.2% and 0.3% respectively. I suppose that’s because ‘no interest rate’ rise is good news for stocks, even though the market was just warming to the opposite narrative.
But it’s all relative. And what I find interesting is the chart below, which shows the relative performance of gold stocks (the HUI index) versus the S&P 500. Check it out…
[Click to enlarge]
The majority of this chart shows a downward sloping trend. That reflects gold stocks underperforming the S&P 500. The chart then flat lines in the second half of 2015, which tells you both gold stocks and the broader stock market performed similarly.
But in early 2016, things changed dramatically. The rising line in the chart tells you that gold stocks started to outperform aggressively. And, as you can see by the moving averages (the blue and red lines), the trend has turned up.
This could reflect the start of a long term move. In other words, you could see gold stocks outperform the S&P 500 for some time to come…perhaps even years.
But it’s never wise to get too excited about one data point. And one bad employment number doesn’t mean a US interest rate rise is off the table for good.
It won’t take long to find out what the boss thinks of it. As the Financial Times reports:
‘Investors will tune in to Ms Yellen’s speech to the World Affairs Council of Philadelphia on Monday as they continue to digest Friday’s disappointing jobs report. “Markets will be waiting with bated breath to see whether she strikes a more hawkish tone or one of continued cautiousness ahead of the June FOMC meeting,” said economists at Bank of America.
‘Following weak job growth numbers, expectations for a rate rise in June slid to just 2 per cent, while odds of a move in July nearly halved to 27.5 per cent from a day earlier, according to Bloomberg calculations of movements in federal funds futures.’
Yes, her speech will be interesting indeed. After spending the past few weeks orchestrating a ‘tightening’ strategy, the Fed now looks a little lost. A June hike is off the table, and July is a low probability. The Fed next meets in September — even that looks like a long shot for the next move higher.
The risk for the Fed is that, in the market’s eyes, it’s growing increasingly impotent.
Let me put that into context. The way to make money over the past few years has been to make bets based on Fed announcements. The Fed spends months telling the market what it plans to do, and by the time it acts the market has already priced the move in.
So those responding to the Fed early make easy money.
In recent weeks, the Fed started to prepare the market for an interest rate rise. So the punters bought the US dollar and sold, among other things, gold and gold stocks. But this unspoken deal between the market and the Fed came to a grinding halt on Friday with the results of one set of data.
The hedge funds who have made their living acting early on Fed ‘communications’ lost a lot of money on Friday. It is now clear that, while the Fed wants to raise rates (for banks and insurance companies), they simply may not be able to do so.
That this is now obvious is dangerous for a market formerly nurtured and comforted by the Fed.
This may all turn out to be hand-wringing over nothing. The May employment numbers could turn out to be a one-off. Strong data in the weeks ahead may put a rate rise for July back on the table — and the Fed back in the narrator’s seat.
If not, the world’s largest economic and stock market manager will need to shift their story markedly. That would only be another blow for the Fed’s dwindling credibility.
For Markets and Money