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Wednesday, 30 March 2022

March 22 Payrolls Primer... Damp Squib?

Friday will bring us the next Nonfarm Payrolls report. Once again, it's hotly anticipated, but the importance of payrolls relative to CPI prints has, in my opinion, diminished over the last few months. The labour market is extremely strong and the Fed knows this, so individual payrolls prints are unlikely to be quite the same driver as we have seen in other periods. 


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What is the Payrolls Report? 
The Nonfarm Payrolls report is released monthly and contains a whole host of data about the labour market in the US. Through the pandemic for a time it was less important, but generally it is a critical and highly watched piece of data. The employment report is likely to shape the Fed's reaction function from now on, unless inflation becomes even more persistent. The report is release on the first Friday of the month at 08:30 ET (that's 13:30 UKT). 

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What's Expected? 

Economists are currently predicting an increase of 480,000 jobs for the month of March. This would be down from the prior month's stellar gains of 678,00. However, that kind of number was clearly unsustainable, so there's little evidence of this being bad for the economy. 

Private Payrolls data released Wednesday showed an increase of 455,000. Note, however, that the ADP report is a notoriously unreliable indicator for the NFP report. I mean, ADP hasn't even accounted for all of March when published. 

What is particularly interesting is that there were big NFP beats in both January and February. This probably means that economists are raising their expectations to avoid being caught on the downside again, and this could well lead to a significant miss in the report on Friday. 


NFP Reports Recently - Trading Economics 

Note, these gains are significantly higher than pre-pandemic levels, where an NFP report would typically see 200k jobs added in a given month. Thus, the pace of job gains continues to be remarkable. 

Don't forget... the payrolls report is both complex and multi-faceted. Key will be the unemployment rate, participation rate and the revisions to the previous months. I have stressed this in recent reports - it pays to be careful. 

The participation rate, for example, has been ticking up higher quite quickly in recent months, and a continuation of this trend could easily lead to a rise in the unemployment rate if the hiring rate slows at all. These kind of situations could start to complicate the Fed narrative, although the inflation objective is so clearly dominant at the moment that I suspect little can derail 50bps at the next meeting... beyond that, who knows. 



What do I expect? 
As already mentioned, the consensus has been too low for the last couple of payrolls reports, so I wouldn't be surprised at all if the tables turned back for this meeting. I personally wouldn't be surprised to see a miss with a print like 250k. This would be pretty sharp and probably lead to a stint of USD weakness - especially if we see a corresponding uptick in the participation rate. 

If we don't see an outright miss, I wouldn't be at all surprised to see some significant downward revisions to prior months. 

What's the trade? 
For me, the USD is already priced for perfection in terms of Fed hikes, so any kind of miss looks like a sign for USD weakness to me. As mentioned at the start though, the focus is all on inflation and not so much on employment. Last month, we had a 0% change in Average Hourly Earnings, which I thought was interesting... if we see the same again then it could really be indicative of wages being squeezed by inflation, but again this is a complex dynamic affected by severe wage pressures in some sectors and not others. 

The trade for me is to be long GBPUSD into the meeting. The £ has been under significant pressure in recent weeks, and I think the £ has a better chance for gains than the Euro following the meeting. Likewise, with a number of risks out of the way for the £, it seems likely to me that we have room to consolidate a bit and make way for a leg higher toward 1.34. After the release of the report, I do think there could be a quick retracement as the market realises this report is not important for Fed policy, but either way, I'd rather be short USD than long going into this report. 


As always, please do reach out with questions, and I will try to be hot and fast with reaction notes to my email subscribers. To subscribe via email, simply fill out the box to the top right... it's free! 




The March Reading List

Welcome to the third reading list of 2022! Given that geopolitics is dominating the news over the last month and a half, I thought it was very much appropriate to emphasise both history and geopolitics in this latest edition. 

Over the course of March, I read on everything from Russian oligarchs to WWII to the previous "empires" of the world. I hope you enjoy reading about what I've been reading, and as always please do keep your recommendations flooding in... I promise I will get around to reading them eventually (there are currently 12 books on the waiting list...). 


I'm ashamed to say that this book has been sat on my shelf for almost a year, and it was only the Russian invasion of Ukraine which made me realise that this was currently essential reading for understanding the geopolitical system and the sanctions process. 

Unsurprisingly, a number of the names in this book are now familiar to anyone who's been paying close attention to the news lately... Abramovich, Gennado, Timchenko, Potanin and so on. There's so much of the rise of Putin which I was totally unaware of, and more than that so much interlinking between the current regime and former KGB members. 

These posts are never supposed to be pure synopses of the books, but rather are designed to outline their relevance for the average reader of the blog, and I have to stress, this is most important reading for everyone... simply because it is so current, and to understand the complex world of sanctions, the invasion of Ukraine, and Putin's possible motives, you have to read this book. 

A brief criticism on this book... I don't know if I had an early edition or something, but there was the odd typo / miswritten sentence here and there. But don't let that turn you off, it is most definitely essential and critical reading! The most important takeaway has to be the extent of Russian money/influence embedded not just across London but also the USA, and it is quite frightening to think just how far the money trail might go. 



Next up in my biographies of key historical characters is the magisterial work by Andrew Roberts on Winston Churchill. I bought both the book and the audiobook for this, and I have to say both are stunning... but I would recommend the audiobook as an accompaniment - simply because it makes digesting this 1000 pager a little bit easier. 

This work is simply astonishing. It is comprehensive, yet entertaining... yet also still full of gravitas. Punctuated by many of Churchill's witticisms, Roberts navigates us through the life of this most extraordinary man with an even-handedness which I actually found quite surprising. None of the current Churchill controversies are shied away from - particularly surrounding Churchill's views on race among other issues - and Roberts handles them with extreme nuance and historical perspective. 

Clearly, I could spend most of this review writing about Churchill's various wartime heroisms or exploits, yet I'm not going to because it's frankly pointless to even try to summarise... this book is a titanic achievement, and even the non-history fan would delight in every page. The book takes us through the full range of emotions, from amazement at Churchill's prison escape, to awe at Churchill's prescient war predictions, to tears in his moving speeches... I confess I even felt the dreaded pride that I could claim to be even the same nationality as this most heroic figure. 

Looking to our current situation, one can't help but feel that a Churchillian viewpoint would be most helpful in trying to gauge appropriate responses to the crisis in Ukraine. We must be sure to reflect that the easy path of appeasement of Putin's regime is not the right one, and rather we must seek to impose the maximum pain on the regime while balancing the costs to ourselves. One thing Roberts definitely gets right is the focus on Churchill's mistakes, and at times Churchill did make fatal errors in earlier conquests and Roberts does not spare Churchill for these, but clearly the man was right at the time for the job, and has rightly been celebrated as a hero ever since. 



More on leadership next, and I read about the "modern" Prime Ministers and their respective approaches to leadership. This is an extremely good read since more than anything else Richards focuses on the flaws of the various leaders and how these flaws almost inevitably led to each PM's eventual demise. 

What I thought the best takeaway from this book was that generally, the longer a PM is in power, the more likely it is that they will bring about their own downfall. A prime example of this is with the Iron Lady Margaret Thatcher. Initially, she had a relatively solid cabinet whom she relied upon for debate, but after the third election victory, despite having another solid majority, she threw it all away by becoming increasingly convinced in her own convictions. I hope to learn from these lessons myself in any future trials of leadership I may be fortunate enough to have. 

I was also particularly surprised by the biography of Gordon Brown. I found myself with significant sympathy for the crisis which he faced and the completely unfortunate timing of his rise to power. Years in the shadows only then to be eclipsed by a global crisis. Nonetheless, he too was not without flaws with his early musings about a general election only to change his mind time and time again later on. Conversely, where I expected to feel sorry for Theresa May, it turned out I felt less empathy than I did previously... a catalogue of errors played into her failure, and her history as a successful Home Secretary in fact did not prepare her at all for leadership. 

This is definitely a book worth a read for anyone who seeks, or is currently in, a leadership position. The lessons run far and wide, although there does seem to be an inevitability behind many of them, such that even sufficient study wouldn't help prevent that air of invincibility which arises after a long period "on the job". 



Well, this one was a little bit different to the rest, but wow did I learn a lot. I've never studied the Mongols, and prior to reading this all I could have probably told you was that they were the only people to ever invade Russia in the winter successfully. 

Nonetheless, I feel much more erudite on the subject having read Weatherford's absolutely fantastic history of the Mongols. While the title refers to Genghis Khan, it should be stressed that this book goes far beyond the life of Temujin (Genghis Khan's actual name - 1162-1227) and spends a lot of time on how his descendants both expanded, and then frittered away the vast empires. As with all great powers though (see the next section)... their expansion beyond their means and increasing militaristic investments almost always leads to their eventual declines. 

Anyhow, as an introductory text on the Mongols, this is definitely the one to go for - it's less than 300 pages! Significantly shorter than every other book I read this month! Clearly, Genghis Khan has quite the reputation for being a vicious marauder in the West, and yet this book revealed to me that this perception perhaps isn't necessarily as accurate as it first seemed. In fact, Genghis Khan generally hated the principles of torture and needless murder, and offered mercy to cities if they surrendered to him. It was, in fact, some of the descendants who began to engage in much more barbaric acts. 

In other areas the Mongol Empire was also critical to the development of the Western world - in terms of money and trade especially. I'm not quite sure I would go as far as Weatherford does in terms of the importance of the Mongols to today, but no doubt this has changed my perception on just how revolutionary the Mongol Empire was for the world as a whole. 

For those unaware, a map of the extent of the Mongol Empire is below... wow! 


Source: World History Encyclopaedia 


The Rise and Fall of the Great Powers: Paul Kennedy

I think the first disclaimer required with this book comes from the fact it was published in 1988. Thus, the dynamic of the world in these 30+ years has of course shifted dramatically once more since Kennedy authored this book. Nonetheless, the book gives critically important insights into the way in which global pre-eminence shifts. 

The main sections of the book consider the Habsburg Empire, the British Empire, the Industrial Powers in the run to the First World War, the Second World War and the American Century, the Russian Empire / USSR, the resurrection of Japan and the beginnings of China. You may well think this is far too complex a range of topics for one book alone, and I would probably have agreed with you before reading this, but much like Henry Kissinger's "World Order" (see the very first reading list for this), this is a concise, insightful and highly researched investigation of Great Power. 

The central conclusions of Kennedy's work are that economic and military power go hand in hand, but often the decline of economic power can stem from the overspending on military powers. We can see this clearly with the Habsburg and British Empire, the Soviet Union, and also to some extent the US here and now. 

The final chapter of the book is devoted to "predictions" for the future, and here Kennedy (writing in 1988) shows that just being erudite on a subject doesn't make you guaranteed to be accurate (although, in fairness he does admit this himself). Kennedy in my view underestimated the rise of China, but at the same time overestimated the strength of Japan - which has stagnated largely in the last two decades. He also underestimated the likelihood of the collapse of the USSR with hindsight. 

Nonetheless, the lack of predictive correctness hardly matters when you have a book which is so well written and constructed as this one. I am not going to lie, however, you must have a strong interest for geopolitics to even consider reading this one... it is quite academic, lengthy and detailed. You could probably get a good dose of the detail just by reading the first sentence of every chapter and have a good idea for Kennedy's general thoughts and theories. That said, I highly recommend it to the interested or academic audience, it is remarkable reading and deeply insightful. 


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That's all for this month. I hope that many of you will go away and buy some of these ones... I think they are all highly relevant to the current geopolitical situation. 

Next month, I'm changing tack a little bit... but there's still going to be a good dose of history. Firstly, I'm going to be reading (and watching) Hamilton - the version by Ron Chernow. Then, I'm going to be reading Edward Gibbons' first two volumes of The Decline and Fall of the Roman Empire. Well, I'll be honest and say I'm going to try and read it... it was written originally in the 18th century, and will be roughly 1200 pages for these first two volumes. 

Why am I reading it? Good question... it's cropped up in about 5 books I've read recently as a reference, and it was one of both Churchill's and Teddy Roosevelt's favourites... so why not :) 

The change of tack though comes in the form of Nassim Nicholas Taleb. I have a coursework project this month, and I'm totally unashamed to say that I'm going to be re-reading a broad swathe of his works to help with the module. I'm going to go with Fooled by Randomness, Anti-Fragile and Skin in the Game. Why not the Black Swan? I hear you ask. The reason is simply because I read it recently anyway, so there's no need to do it again. Nonetheless, still have a Taleb Trinity for the month ahead, so wish me luck :) 




Monday, 14 March 2022

March 2022 FOMC Primer

Right... let's get to it. Wednesday will bring what will probably be the most important Fed meeting of the year. Sure, we all know that the Fed is going to do a 25bps hike, but the question is where do we go from there? 

The Fed's decisions are darkened by the prospects of economic uncertainty and high inflation.

Hopefully, Wednesday will bring some drama from Fed Chair Powell and we will finally get a better impression of where the Fed sees rates going, what the Ukraine crisis means in terms of uncertainty on Fed policy, and also an idea on the terminal rate / target balance sheet size for the Fed. 

All of this means, there is a huge amount which could affect the outlook for interest rate hikes in 2022. Currently, markets are pricing for 7 rate hikes this year according to Bloomberg. 

I have been very aggressive in recent months saying that this is overpriced, and that the reality is we will see closer to three hikes. I've already revised this once from the beginning of the year (where I expected two). I now change my 2022 forecasts once more, to 4 hikes. But that's it... unless the facts change dramatically, I reckon we will only see 4 hikes this year. (Notice how I've not mentioned the size of the hikes I expect to be enacted ;) ). 

It is useful to begin this primer with where the Fed was just three months ago at the December meeting. At that meeting, forecasts were updated and Fed officials provided their expectations for future policy in the form of "the dots" which are below.

Source: Fed - Summary of Economic Projections

As you can see, at the December meeting, the majority view was for US rates to end 2022 around 0.5-1%. What we will be interested to see is just how much higher these dots are going to be revised in light of the latest inflation data. 

To me, I suspect to see quite a substantial increase - probably with the median dot placed around 1.5%. However, remember that there is only one dot that really matters... and that is Powell's dot. We do not know where this is, but expect the market to take the initial report as a signal to move higher (at 18:00 GMT tomorrow), and then Powell to come out and stress the risks. 

Last thing on the dots... there is NO EVIDENCE WHATSOEVER that Fed policy plays out anywhere close to them, but the market thinks they are useful so there we are. They are just another forward guidance tool. 

The need to act: 

Everyone knows inflation is high, but so what... there is little the Fed can do to stem the surge in global commodity prices. Interest rate hikes will, of course, play into demand destruction. But when shortages are as acute as they are, only extreme volatility can perhaps curb some of the enthusiasm for commodity assets. 

The chart above though, is more concerning. It shows 5y5y inflation expectations (basically, the 5y expected rate in 5y time). These have been edging higher pretty rapidly, and the Fed is likely to be concerned. If longer term inflation expectations are above 2%, it is pretty likely that actual inflation will be above 2%. At some point, the Fed must act to bring inflation expectations down and restore confidence in the population that it has the situation under control.


How to trade the Fed: 
For me, this meeting will go much as the ECB meeting. First, we will see some hawkish policy statement released before the press conference. Then, the presso will start and the questions will pour in, Powell will stress the uncertainty around the outlook, throw in a few concerns about "demand destruction" and "uncertainty from global supply chain issues" and stress the Fed's willingness to "support the economy" should it be necessary. 

After an initial spike in the USD, I would expect to see a fairly quick and rapid reversal in the press conference. This is just my hypothesis, obviously if we get a dovish statement, then it could be the opposite where we see Powell hawk it up later. 

Either way, I suspect the overall effect will be for the USD to be unchanged, but for equities to stage a bit of a rally as I suspect it will always be less bad than the market expected. 

Basically, don't trade anything before the statement, then move the opposite way. 


THAT'S ALL FOLKS: 
That's really all I want to say on here... no doubt more thoughts will cross my mind before the meeting, so those will be going exclusively to email subscribers. Don't worry, it's free to sign up - just use the form at the top right!





Thursday, 3 March 2022

February Nonfarm Payrolls Primer - Don't Judge a Book by its Cover

Tomorrow we will get the payrolls data for February 2022. This is going to be a critical report, although I suspect not as important as the February CPI report will be just before the Fed meeting later this month. 

The headline consensus number is for 400k jobs added. The prior was 467k. However, it's worth noting the range of estimates for this month - with a low estimate of 200k and a high estimate of 730k. 


What is the Payrolls Report? 

The Nonfarm Payrolls report is released monthly and contains a whole host of data about the labour market in the US. Through the pandemic for a time it was less important, but generally it is a critical and highly watched piece of data. The employment report is likely to shape the Fed's reaction function from now on, unless inflation becomes even more persistent. The report is release on the first Friday of the month at 08:30 ET (that's 13:30 UKT). 

Expectations: 
Expected to come in at around 400k. Although, it must be said that the estimates recently have been miles off the actuals. The range of estimates of 530k so really anything in the range of 300k-500k is probably in-line in my view. Morgan Stanley is highest at 730k, Deutsche with the lowest. 

DON'T JUDGE A BOOK BY ITS COVER: 
The title of this piece is don't judge a book by its cover - this is simply because there is so much other data released with the payrolls report which I believe is likely to affect the outcome more than just the headline number. For example, I see the unemployment rate number as particularly critical in terms of judging Fed policy further out. Sure, they are certainly going to hike this month as Powell alluded to in recent congressional testimony. However, I still think there are severe risks to hikes further down the line. 





Remember, the Fed has a dual mandate for both employment and inflation. The two charts below show the unemployment rate and the participation rate. Note how both ticked up in the previous period. This is a trend I expect to continue - I would not be surprised to see another increase in participation and also a jump higher in unemployment rate. 

This means that the initial headline report will be judged, and then it will be a question of whether the other numbers cause the market to reverse whichever way it moves initially. 


The unemployment rate has jumped higher in the previous period (Refinitiv)


Participation really jumped higher in the last few months (Refinitiv)

Basically, I will not be trading this event. It seems far too complex to get a clear read on, and I'm not entirely convinced the market will focus on it if we have a lot of headline from Russia/Ukraine as well in the background. The best way to play this, in my view, is in terms of Fed expectations. 

Scenarios: 

If we get strong headline, lower unemployment and decent participation, I suspect we will see a greater expectation for Fed hikes and hence USD stronger, gold lower and equities probably lower. 

If we get a miss on the headline, I think this is unimportant if the other factors point to higher rates. Also be sure to watch average hourly earnings. The Fed has been watching this measure increasingly closely to see if we have any evidence for a WAGE PRICE SPIRAL. 


Another big increase in hourly earnings will likely add more pressure for the Fed to hike (Refinitiv)

My Expectation: 
Headline number to come in lower, the unemployment rate to rise, and the participation to increase. I will put myself on the line and say headline number of 250k. I expect this miss since forecasters significantly underestimated gains last time, so betting the other way is often a good shout. 

In this situation, I expect lower pricing for Fed hikes, and this will likely mean lower USD, higher gold and higher equities. Gold would be the best long in this case since it implies the Fed will be less hawkish despite escalating inflation! 

As always, please do reach out with your questions.