By Brian Dolan, Head Market Strategist Yellen Signals Caution Ahead of March Jobs Report
In a speech to the Economic Club of New York today, Fed Chair Janet Yellen sounded exceptionally reserved in her economic outlook, saying that caution in raising rates is “especially warranted.” Yellen cited concerns ranging from global developments to “somewhat mixed” US data so far in 2016 as reasons why the Fed rate path remains “necessarily uncertain.”
Following the latest FOMC statement and economic projections on March 16, Yellen’s comments today reinforce the idea that the Fed is not on a pre-determined path to higher rates. Yellen made it plain that the burden of proof is on the incoming economic data and global developments to justify another rate hike. And she also made it clear that the burden of proof is not close to being met.
Interest rate markets had responded to the March 16 FOMC statement by pricing out small expectations (around 25% probability down to 2%) of an April hike. Yellen’s comments today sent market expectations of a June 15 rate hike down sharply from about 37% to around 25%. (See chart below.) They’re likely to keep drifting lower as that meeting approaches unless there is a meaningful and clear rebound in US data.
Source: Bloomberg; DriveWealth
Is the Fed/Risk Sentiment Relationship Breaking Down?
In the recent past, it has been customary for stocks and risk assets to be buoyed by indications that the Fed would stay lower for longer. That past response may be in the process of changing, though it is too soon to tell. To be sure, stocks have rallied again today and are testing the highs for the current rebound around 2056 (based on the S&P 500), but are only up about 1.5% since the Mar. 16 Fed decision, possibly suggesting that the steady-Fed-effect is beginning to fade. The question for investors now is whether stocks are able to extend gains further, now that the rate hike horizon appears to be clear for the next 3+ months.
Other bellwethers to keep an eye on: the US dollar is decidedly weaker on lowered US rate hike expectations, which is to be expected. A softer US dollar is generally correlated with gains in US stocks, which is also holding up in the immediate wake of Yellen’s comments. However, a weaker US dollar is also typically linked to stronger commodities, oil in particular. And that’s not holding up well at all. Commodities (CRB index) have now given back all of their gains following the Mar. 16 Fed decision, which suggests an underlying weakness in the broader economic outlook.
And that’s the reason for a possible breakdown in the well-worn relationship between the Fed and risk sentiment. The economic reality facing Janet Yellen is the same one facing stock markets and other risk assets: anemic global growth and stuttering US data, highlighted by backsliding in wages and spending. Commodities have simply been the first to react, as they often are.
Data Does Matter—US Jobs on Tap
This set of circumstances shines the spotlight on Friday’s March US employment report more so than usual. Consensus forecasts are for a slightly below-trend NFP increase of +205K (2-year average is about +240K) and a steady 4.9% unemployment rate. If even close to expectations, and today’s ADP report suggests it will be, such a reading would hardly be disastrous, suggesting a still solid US labor market. It would take a major shortfall to rattle markets overall outlook, which is that US continues to trudge along at around 2.0-2.3% annualized GDP.
More likely, the focus will stay on the wages and earnings data, where average hourly earnings are expected to increase +0.2% MoM (prior -0.1%); YoY steady at 2.2%. A weak reading on wages could potentially have an outsized impact on market sentiment, reminding investors that US consumers are still vulnerable and reinforcing Yellen’s reasons for caution. A stronger wages report, on the other hand, could be just what markets need to extend the rebound and push higher still.
Source: Bloomberg; DriveWealth
On the technicals, there are some early warning signs of a potential top forming. S&P 500 momentum studies are in overbought territory and potentially showing bearish divergences (meaning prices may fall). Trend readings are still at non-trend levels, suggesting momentum signals are more relevant. Price has been flirting with the daily Tenkan line (purple line), the first line of support on Ichimoku charts, currently at 2047. A daily close below that level would suggest scope for a pullback to 1981 initially (Kijun line-Yellow line); top of the cloud at 1945 is next support. Also, today’s price candle is potentially forming a bearish ‘shooting star’ topping pattern (the daily candle is not finalized as of this writing), which would be confirmed by a large down candle tomorrow. Stay tuned and don’t get caught flat-footed.