“We're going through a period of retrenchment as the dynamics of the playing field are changing.”

— Ken Griffin of Citadel LLC

Before you say anything, I know exactly what you’re thinking. What happened to the article scheduled for Friday?

Here’s the brief answer, I wanted to digest the NFP data coming out later in the afternoon, and being completely honest, writing a piece without covering such a crucial reading wouldn’t be the best value for the MMH community!

Now, let’s get into it!

Non-Farm Payroll Data & The Labour Market

Figure 1: U.S Unemployment Rate

Friday we had the non-farm payroll data release, and once again the actual print beat the expectations of 300k totalling 315k job additions. Now, what I always tend to focus on isn’t the number of jobs added or whether the print "beat” or “missed” the prediction. That doesn’t really matter. What matters to me and what should matter to you is the below:

Figure 2: U.S Labour Market Data

Average hourly earnings. The reason this measurement holds more weight is because non-farm employment numbers only tell you the change in the number of people employed during the previous month; whereas average hourly earnings gives you a broader horizon to get a picture of how conditions are shaping up. Here’s how.

If non-farm data beat expectations yet average hourly earnings are lower by 1% (YoY). What benefit does that have to the economy’s GDP? What value is it to fill the labour market but employees aren’t paid well enough to spark activity within their domestic economy? Absolutely none. The point of tracking such data is to ensure that the labour market remains strong but, more importantly, average hourly earnings grow. So the next time you look at NFP pay attention to more than what the number is, look at how the % change in hourly earnings because that will tell you a lot about the health of the labour market.

Unemployment Rate Hits 3.7%

Unsurprisingly, we saw the unemployment rate tick higher shown in figure 1 to 3.7%. As a result of the increase in interest rates, we’ve seen massive layoffs across the U.S tech sector; names such as Paypal, Stripe & Robinhood. As it stands the federal funds rate is 2.5% and from figure 3 below we can see the expectations for the upcoming rate decision are tilted towards either a 50bps or 75bps hike.

Figure 3: Target Rate Probabilities For Fed 21 Sept Meeting

One reason I love looking at the CME FedWatch Tool (source for the above chart), is because you can see the live probabilities and changes in investors’ minds for the Fed funds rate. Predicated on what may be happening, you’ll see investors betting on either a low-size hike, i.e 25-50bps or a larger-sized hike leaning towards 75bps.

Take a look at figure 4.

Figure 4: Probability % of Fed Funds Rate

Just over a month ago now, market participants were betting on a 25bps hike, probably due to the dovish comments we heard from Jay Powell on the “strength of the U.S labour market”, “neutral rates” and a ‘soft landing’. Shift your focus to 1 Week 26 AUG 2022. What happened that weekend? That’s it, The Jackson Hole summit. From this, we saw equities take a sell-off after listening to a firm message from the man Jay Powell that they will not make the same mistake as they did during the 70’s inflation peak. The result, a sell in any risk-on asset. Plus, Jay Powell basically put a 75bps hike back on the map again so that fuelled bets that we will see further aggressive tightening into deeper restrictive territory in monetary policy.

The Dollar Surge

DXY Index

The last run I can remember the dollar having like this must have been the rally of late 2014 which ran into 2016 causing many companies like Apple to cut their revenue and profit forecasts.

For those who can recall a previous article, we looked at how one could have positioned oneself in a long-on-the-dollar ETF trade to bet on its inevitable appreciation against a basket of G10 pairs. That trade to date has delivered 14%, so believe me I’m just as gutted I missed out on such a good opportunity.

UUP Performance View

Looking forward, I see a short on the dollar as a good opportunity for some alpha as we draw near to the end of the hiking cycle sometime in ‘23. The extension and bull run we have seen have been mainly attributed to rising global fears of war, a recession, an energy crisis across Europe and not to mention a widening interest rate differential between the Fed and other major central banks globally. To touch on the last point and the importance it has, put yourself in the shoes of an investment manager or a large body in charge of capital placement. The drivers of capital flows have all revolved around the stability and growth potential of a nation; meaning the political policy, monetary policy, GDP outlooks and growth. So when eyeing up the U.S economy against other G-10 nations you can see why it would stand out and attract the large majority of capital flows. Number 1, the U.S doesn’t have the basic energy exposure many of the European countries have, 2, the U.S when compared to G-7 nations has a politically sound policy. Take a look at Italy and you’ll understand the importance of that point, Italy has been hit with the brunt of the stick both politically and with inflationary and other economic conditions. Finally reason number 3, the U.S is simply ahead on the tightening cycle within financial conditions so the U.S presents the safety of capital and a good yield.

So, due to these fundamental and economic drivers, the flow of foreign capital has found a haven in the dollar which has paid dividends. Coming out of this I am keeping an eye out for the other side.

I’ll leave you with this quote from Ken Griffin:

“We think that excellence in investing comes from focus.”

— Ken Griffin

Appreciate you as always for reading until this point! Do me a favour and share this with someone you know will pick up some value, subscribe and share your thoughts and ideas with me on Twitter, LinkedIn or Instagram!

Until next time