Joel Kruger
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Good News Is Bad News - So why did US equities rally so hard on Friday? I stuck around to wait for the US NFP report and watched for about an hour after. I then closed up shop for the weekend and went off to enjoy the day with family. It wasn't until Saturday night that I looked to see where the market closed. Wow! What a recovery rally! Before doing analysis of my own, I couldn't help but notice, all of the major financial sites and leading publications had attributed the rise in stocks to the much better than expected employment report. But did this make any sense? For the past several months, if not years, it has been very clear that good news for the US economy is bad news for equity markets. Any signs of better than expected US economic data only reinforces the fact that the Fed is likely to reverse policy sooner than later; something the markets do not want. So how is it that all of a sudden all of the major media outlets were attributing the rally in stocks to the strong US data. It just doesn't add up. So what was the market really thinking?
Bad News Is Good News - In my view, the rally in risk assets can be reconciled by the fact that the Fed has tied policy reversal to the unemployment rate. So while the NFP print was way better than expected, the fact that unemployment ticked back up to 7.3% means the Fed is now one step further away from its reversal threshold. This is the most logical explanation for the rally in stocks. But to think stocks rallied because of the better than expected NFP print would be a serious miscalculation. Still, I do think the recovery rally was unjustified. The economy is showing signs of improvement and the Fed needs to seriously consider an initial taper. I believe markets will start to price this in more seriously in the sessions ahead, and we will once again see equity markets back under pressure. Friday price action is always nonsense, and my recommendation would be to ignore the noise of the post NFP recovery rally and focus on the likelihood of a deeper pullback in stocks over the coming days and weeks.
Understanding The Yen - Currency markets on the other hand seem to have gotten it right. The USD was stronger across the board on the day, with the FX market pricing in the sooner than later Fed taper, narrowing yield differentials back in favor of the buck. So it wasn't a better data = better USD reaction from FX markets, it was a sooner than later Fed taper = higher USD reaction. This brings me to the next major point of discussion. How can we make sense of USD/JPY? Can USD/JPY rally with falling US equity prices? This is where I think many traders might be missing the point. I do think USD/JPY can rally significantly, even with the anticipated decline in US stocks over the medium-term. This is because everything comes down to yield differentials. Going forward (as the US economy continues to recover and the Fed begins to exit), yield differentials will only widen out more decisively in favor of the US Dollar and the US Dollar will benefit greatly against the Yen. So to think that for USD/JPY to push higher, we need to see more risk on trade and more strength in US equities, would be incorrect in my view. While there might still be some attraction to Yen on misplaced flight to safety correlations that no longer apply (Yen was never a safe haven currency to begin with), ultimately, it is yield differentials that will drive USD/JPY significantly higher in the months ahead. USD/JPY therefore rallied on Friday because the Fed is closer to tapering. The rally had nothing to do with the fact that equities regained a bid tone.
Good News Is Bad News - So why did US equities rally so hard on Friday? I stuck around to wait for the US NFP report and watched for about an hour after. I then closed up shop for the weekend and went off to enjoy the day with family. It wasn't until Saturday night that I looked to see where the market closed. Wow! What a recovery rally! Before doing analysis of my own, I couldn't help but notice, all of the major financial sites and leading publications had attributed the rise in stocks to the much better than expected employment report. But did this make any sense? For the past several months, if not years, it has been very clear that good news for the US economy is bad news for equity markets. Any signs of better than expected US economic data only reinforces the fact that the Fed is likely to reverse policy sooner than later; something the markets do not want. So how is it that all of a sudden all of the major media outlets were attributing the rally in stocks to the strong US data. It just doesn't add up. So what was the market really thinking?
Bad News Is Good News - In my view, the rally in risk assets can be reconciled by the fact that the Fed has tied policy reversal to the unemployment rate. So while the NFP print was way better than expected, the fact that unemployment ticked back up to 7.3% means the Fed is now one step further away from its reversal threshold. This is the most logical explanation for the rally in stocks. But to think stocks rallied because of the better than expected NFP print would be a serious miscalculation. Still, I do think the recovery rally was unjustified. The economy is showing signs of improvement and the Fed needs to seriously consider an initial taper. I believe markets will start to price this in more seriously in the sessions ahead, and we will once again see equity markets back under pressure. Friday price action is always nonsense, and my recommendation would be to ignore the noise of the post NFP recovery rally and focus on the likelihood of a deeper pullback in stocks over the coming days and weeks.
Understanding The Yen - Currency markets on the other hand seem to have gotten it right. The USD was stronger across the board on the day, with the FX market pricing in the sooner than later Fed taper, narrowing yield differentials back in favor of the buck. So it wasn't a better data = better USD reaction from FX markets, it was a sooner than later Fed taper = higher USD reaction. This brings me to the next major point of discussion. How can we make sense of USD/JPY? Can USD/JPY rally with falling US equity prices? This is where I think many traders might be missing the point. I do think USD/JPY can rally significantly, even with the anticipated decline in US stocks over the medium-term. This is because everything comes down to yield differentials. Going forward (as the US economy continues to recover and the Fed begins to exit), yield differentials will only widen out more decisively in favor of the US Dollar and the US Dollar will benefit greatly against the Yen. So to think that for USD/JPY to push higher, we need to see more risk on trade and more strength in US equities, would be incorrect in my view. While there might still be some attraction to Yen on misplaced flight to safety correlations that no longer apply (Yen was never a safe haven currency to begin with), ultimately, it is yield differentials that will drive USD/JPY significantly higher in the months ahead. USD/JPY therefore rallied on Friday because the Fed is closer to tapering. The rally had nothing to do with the fact that equities regained a bid tone.
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