Can you imagine sitting in your home, watching The Weather Channel, buckling down for a major hurricane, and then suddenly the hurricane just disappears from the screen? What on Earth would you do? It’s not like it suddenly changed course—I’m talking about the whole storm system just disappearing from the screen! I’d be pretty scared and confused if I saw that, wouldn’t you be, too? That is kind of what happened today with the Fed and the employment numbers.
Today’s employment numbers were shockingly disappointing; no matter how you look at it. The September increase in payrolls was reported at only 142,000 as opposed to an expected 200-225k. August payrolls were revised down by 37,000, breaking a four-year streak of positive revisions for that month. Average Hourly Earnings, which were expected to tick up, stayed flat month-over-month. My expectations in last week’s post for a strong September number and a strong positive August revision were clearly wrong.
The Fed has painted itself into a very uncomfortable and precarious corner. Many voting Federal Open Market Committee (FOMC) members spoke this week about still raising the Fed Funds rate in 2015. Some officials like John Williams, President of the San Francisco Fed, spoke about an October raise as reasonable on Thursday. President of the Boston Fed, Eric Rosengren, said that raising rates in 2015 was, “A reasonable forecast” just one hour before the employment numbers came out.It has always been widely believed that the Fed sees the numbers before we do, so confusion reigns.
Currently, the 2-year Treasury Note is yielding 55 basis points (down 10 basis points pre-employment numbers). The Fed Funds Futures contracts view the probability of an October meeting hike at 6%, and 28% at the December meeting. The futures show that the market, where actual people put their money down to express their opinion, does not expect a hike in the funds rate until the March 2016 meeting. Therefore, if the Fed tightens in 2015, the market is clearly off-sides and will pay a harsh price. On the other hand, if the Fed does not go in 2015, then what is left of their credibility? Either way, this is a terrible backdrop for just about any market you can think of. If the Fed had just gone in September and then said they would be patient for the next increase, this would be one huge question the market wouldn’t have to deal with.
Equity and Corporate Credit markets are getting hit hard this morning. In the area of Investment Grade credit, the mood was already bad. The biggest new issue of the week, the $14.6 billion Hewlett Packard deal, came out Wednesday at a 50 basis point new issue premium to secondary, and promptly found itself trading 10 basis points wider in spread by Thursday morning. This morning, the issue is wider by another 10 basis points in spread. High Yield continues to get thrashed as well. Commodities—even with a weaker dollar this morning—are getting hit hard.
Looking at the yield curve, post-employment, there’s not much upside in a 2-year Treasury Note yielding 55 basis points or a 3-year yielding 79 basis points. There’s just too much exposure to the Fed following through with a 2015 hike. The best performer on the curve is the 5-year note, dropping 14 basis points in yield to 1.23%. I think the 5-year has room to gain more here. The yield dropped to a low of 1.15% in January 2015, and based on today’s information and market behavior, the 5-year can challenge that low in the days ahead.
I continue to favor Municipals with 10- to 15-year final maturities and 7-10 year calls.
Member SIPC & FINRA. Advisory services offered throughSWBC Investment Company, a Registered Investment Advisor.
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