Friday, May 2, 2014

Chasing Tail

It only took a few seconds to elicit the knee-jerk reaction to the strong April jobs report this morning. While certainly not unusual for the volatile monthly series, the kinetics in the market were particularly telling towards positioning we believe became actionably offsides and expectations that continue to place the cart before the horse. 

Within moments, the CME Fed Watch - which tracks rate hike expectations using its Fed fund futures contracts, shifted probabilities forward from July to June 2015. At the same time, 10-year yields surged more than 3.5% higher than the previous close. The dollar, which had remained under pressure with the slump in yields this week, also caught a strong bid and tacked on ~ 0.40%. Gold and silver - which strengthened leading into the report, reversed lower and the equity markets spiked to their respective highs. 

Then everything reversed. 

By 10:45am, 10-year yields slipped - then fell below Thursday's close. The dollar sold off and went negative. Gold and silver surged more than 1.4% and 2.75%, respectively - and the equity markets found themselves in the red.

The long and short of things (and for lack of better eastern wisdom) - a dog eventually gets dizzy chasing its own tail. The markets have been chasing performance trends for so long, that they a.) have lost track why, and b.) have confused strong economic data with expectations of a continuation of current market conditions and rate hikes by the Fed next year. 

We have argued over the past several weeks (most recently Here), that as the Fed steps further away from their extraordinary monetary policies a dowry will likely be paid back in the market. As this occurs, the dog will start chasing its tail again, but in the opposite direction and likely pushing rate hike expectations out considerably. 

To a large degree we have witnessed the beginnings of these new trends this year as the bond and commodity markets have outperformed the equity markets and as higher beta indexes underperform and roll-over. The counterintuitive market reflexes have also held true as precious metals continue to do well when strong economic data is read in the US - as it further strengthens the likelihood that the Fed is in fact stepping away from what eventually became disinflationary policy. The currency markets have also represented this shift cleanly with commodity currencies and the euro strongly outperforming the dollar. Adding fuel to the fire has been the retracement in the Nikkei this year, which we suspect has further room to run on the downside and the yen which appears ready to roil off-balance positioning once again.