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Friday January 4, 2008 - 13:08:07 GMT
Black Swan Capital - www.blackswantrading.com

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Hanging on the Jobs Number Again


FX Trading – Hanging on the jobs number again

The Fed Funds futures are factoring a rate cut from the Fed.  This is the best the market has to offer in terms of all available information.  And we have nothing better to add.  But, it may all be for naught if today’s non-farm payroll number comes in better than expected.  And of course if today’s job number is dismal, then a couple of cuts will be factored in to Fed Funds futures, at least. 

We are no experts on Fed Funds or the inner workings of Federal Open Market Committee Meetings. But, when we step back and look at the weekly chart of the Fed Funds futures contract (below), we notice how aggressively Mr. Greenspan moved Fed Funds back 2000-2004. 
 

[Chart not available in text format]

Mr. G’s mission was to save the world from deflation.  And he did, thanks to effectively creating free money for all takers at 1%.  And we wonder why we have a credit problem? 

And now, despite the cat-calls of rising inflationary pressures, we think the stage is set for global deflation once again if the wheels of credit come off the tracks.  Our simple logic flow is this:

No Credit from the World’s Deepest Capital Markets » Falling Demand Everywhere » Lower Asset Prices (stocks and commodities) » Consumer Savings » Rebalancing Global Imbalances » Deflation

Today there is an article in The Wall Street Journal getting some play, suggesting the Fed will not be able to cut because of rising inflationary pressures—mainly from rising oil prices.  Well, maybe. 

We direct your attention to another article which appeared in the Financial Times yesterday, written by Alan Reynolds, economist and senior fellow with the Cato Institute.  Mr. Reynolds talked about the idea that it’s now taken for granted that rising oil prices requires tighter monetary policy i.e. relative higher Fed Funds interest rate.  But, he points out that this seemingly layup idea was challenged in a study by none other than our own Ben Bernanke—before he was anointed our illustrious Fed Chairman. 

“In 1983, the economist James Hamilton shocked the profession by showing that ‘all but one of the US recessions since world war two have been preceded, typically with a lag of around three-fourths of a year, by a dramatic increase in the price of crude petroleum’.
 
“Professor Hamilton’s thesis was challenged in 1997 by Mr Bernanke, Mark Gertler and Mark Watson. It is difficult to isolate the effect of oil prices on recessions, they argued, because ‘a number of the most significant tightenings of US monetary policy have followed on the heels of major increases in the price of imported oil’. They found that ‘an important part of the effect of oil price shocks on the economy results not from the change in oil prices per se, but from the resulting tightening of monetary policy’.
 
“… In 2007, by contrast, the Fed stopped chasing higher oil prices with higher interest rates. As a result, the US embarked on a fascinating new experiment in which oil prices and interest rates were moving in different directions for a change.

“If the emphasis on oil prices in Prof Hamilton’s 1983 study is correct, the US economy is likely to slip into recession because of higher energy costs alone, regardless of what the Fed does. If Mr Bernanke’s 1997 study is right, timely reductions in the Fed funds rate should avert such a recession.”

Who has it right, the WSJ or the Financial Times story?  We likely won’t learn that answer today.  But…as we flailed about with our charts, thinking about this conundrum, we compared the weekly Fed Funds futures with the US$ index and came up with this little ditty…

 [Chart not available in text format]


…we lagged the Fed Funds by about 24-months and the two price series line up nicely.  Pure coincidence?  Maybe!  But if not, it might suggest that today’s WSJ article is right and Fed Funds rate won’t be dropping precipitously as now expected. 

We think a precipitous drop in the Fed Funds rate is very much a part of the current dollar price i.e. that discounting thing.  So maybe there is a big surprise in the offing at some point early this year. 

Anyway, my head is starting to hurt.  I just did way too much heavy lifting (or confusing) for a Friday.  Jobs report is out in an hour.  Given the time frame of most of the currency crowd, that’s all that matters anyway.

Have a great weekend.

 

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