The Week Ahead: Week Of February 8, 2016

What the January NFP report means for Fed policy

As the monthly tradition dictates, traders eagerly awaited today’s US jobs report with the (lack of) patience of a kid on Christmas. When the report was finally unveiled, it was by no means the anticipated “Red Ryder Carbine Action 200-shot Range Model air rifle with a compass in the stock and ‘this thing which tells time‘(a sundial)” that Ralphie Parker desperately wanted in the classic 1983 film “A Christmas Story,” but it’s hardly as disappointing as some have made it out to be.

Overall, the US economy created 151k jobs in January, below the consensus estimate of 190k jobs, and roughly in line with our model’s 160k estimate. The revisions did little to take the edge off the disappointing number of jobs created, with a net subtraction of -2k jobs from the previous two months’ reports.

While the overall quantity of jobs was certainly a disappointment relative to some traders’ expectations, the quality of these jobs was much stronger than we’ve seen of late. Specifically, the average hourly earnings figure rose 0.5% m/m, above the 0.3% rise expected and the highest month-over-month wage increase we’ve seen since 2006! On a year-over-year basis, wages rose 2.5%, well exceeding the rate of inflation. We also saw average weekly hours edge upward to 34.6 hours from 34.5 last month.

In fact, some have argued that today’s employment report is the first sign that the massive “slack” in the labor market is finally dissipating. In other words, we should expect job creation to downshift slightly and wages to rise sharply in a “tight” labor market. We don’t necessarily want to read too much into a single month’s jobs report (especially when last month’s release showed the exact opposite situation – high job growth and low wage growth), but it definitely bears watching as we move through H1 2016.

In terms of Federal Reserve policy, today’s report is unlikely to tip the scales meaningfully. Despite the most recent “dot chart,” we believe that a rate hike in the March FOMC meeting is highly improbable given the ongoing market turmoil and concerns about slowing global growth. At a minimum, it suggests that the Fed Funds futures market’s implied forecast of zero rate hikes at all this year may still be proven overly pessimistic.

Market Reaction

In handicapping the market’s reaction to any big release, it’s critical to consider the recent context. In this case, the US dollar was in the midst of its worst week in years and was deeply oversold on a short-term basis. Therefore, dollar bears were looking for any reason to take profits ahead of the weekend, and because today’s jobs report wasn’t unanimously awful, we’re seeing a bit of a bounceback in the world’s reserve currency. After briefly spiking to nearly 1.1250, EUR/USD is now trading down around 100 pips to 1.1125, while USD/JPY is also tacking on around 100 pips from its low to 117.30.

The reaction in other markets is more nuanced. On the commodities front, both oil and gold have taken a turn for the worse based on the dollar’s strength. Meanwhile, the yield on the benchmark 10-Year treasury bond is rising to 1.89% as we go to press. Whether these moves continue into next week remains to be seen, but it’s clear that today’s jobs report was not as bad as it appeared at first glance.

The US stock markets have been trying to stabilize in recent times following the wobble at the start of the year, but so far with little success. Concerns over the global economy are still there and as such traders are not showing much enthusiasm to buy stocks even if government bond yields are at historically low levels. The world’s major central banks have either expanded their unconventional policy tools further, promised to do so or, in the case of the Fed and BoE, dropped their previously hawkish stance. The fourth quarter US earnings results have been poor, with the exception of a few names such as Facebook (O:FB). So we are not out of the woods yet. But there is a possibility for a short-term recovery from these depressed levels. At least that’s what the charts are pointing to, anyway.

More on that below, but the rebounding prices of oil and metals have provided some support to commodity stocks recently. With regards to oil, there is lots of uncertainty still hanging over the market and traders are getting used to wild daily price swings in and around the $30 area. Essentially, we have seen tentative signs that the buyers are stepping back in but because there has been no confirmation of a change in the trend yet, they are rightly being nimble. And it is pretty much a similar story for the stock markets – lots of choppy price action as both the bulls and bears battle for control, but there’s still no clear winner.

But as can be seen from the daily chart of the Russell 2000, below, even small-cap US stocks are trying to regain their poise. The index is attempting to find a base around the psychologically-important 1000 level; here it has formed several bullish-looking candlestick formations in recent days, but as mentioned with very little follow-through in the buying pressure. The convergence of two Fibonacci extension levels from as many price swings around the point D of an ABCD price pattern means there’s also a bullish Butterfly formation in the making around these levels. This, combined with the RSI’s bullish divergence with the index is suggesting that at the very least the index is due for an oversold bounce – if we haven’t already seen one, that is. It is not a good sign that the RSI has recovered from oversold conditions but the underlying Russell index hasn’t.

If the Russell does manage to bounce, it will still need to clear some important resistance levels that are now looming large at 1040/2 and then the 1074/5 area. These are the respective low points from 2014 and 2015. Bullish traders should therefore remain nimble. Indeed, it could be that some speculators may well be waiting to sell once the markets stage a more profound recovery, now that the longer-term technical outlook is clearly bearish. But if the market falls further without even staging a small recovery, this would be a very bearish sign. In any event, a potential closing break below the 161.8% extension level of the BC swing at 990 would be a bearish development. If this were to happen, we could see some further sharp drops before the buyers try to make another attempt at forming a base.