That story that looked so good this morning ..... just forget about it, would you?

Friday 3rd June 2016

That story that looked so good this morning ..... just forget about it, would you?

ref :- " Odds for interest rate hikes plunge after major jobs report miss " , CNBC online

You're never very far away from making yourself look foolish in this game, but sometimes you get lucky too . We had been thinking about looking at a Bloomberg article that pointed out how 2yr yields on US Treasuries were now more than 50 basis points higher than those on their UK Gilt counterparts  --  the widest differential between the two for 16 years. It was a story that encompassed the two crucial themes of the moment : how the widening yield differential reflected the growing prospect of  US rate hikes on the one hand, and lower yields in the UK  as a result of increased chances of a Brexit vote on the other.

The "flight-to-quality" effect that has pushed Gilt prices higher (and yields lower), and the likelihood that the Bank of England may have to slash interest rates to zero should the UK economy be damaged by a decision to quit Europe, mean that the UK side of the equation still holds up pretty well, but the US rate hike story ? Not so much .....

We'd like to say that we had an inkling that something unexpected was in the air ......  not true of course, but whatever the reason we decided to hold fire on things until the hugely important US Jobs data was out of the way. Just as well, as it turned out ..... the Non-farm Payrolls number for May came in at a measly +38,000 (expected +160,000). Confusingly, the unemployment rate fell to 4.7% (expected 4.9%) but this was put down to Americans leaving the workplace and all attention is on the payrolls number . Unsurprisingly, it has dented expectations of the next US rate hike, sending bond yields tumbling (and prices higher) and the dollar lower. Even stocks , which usually follow the bright side of a rates "lower for longer" scenario, are suffering after the release of data that undermines recent confidence.

It's always worth a look to see what Fed Funds futures are telling us about the markets' take on the timing of the next hike (See www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html)  . After these job numbers things look rather different all of a sudden, and we can compare them to probabilities before the data release. They're still all over the place and yet to settle down but still .... :

June probability             5%        (was 21%)

July                               35%       (was 58%)

Sept                              49%       (was 66%)

Nov                               52%       (was 68%)

Dec                               68%       (was 79%)

Things can change in an instant. That story that first caught our eye, about 2yr yield differentials going out to 52 basis points US over UK, and going to the moon ? Currently trading at 44, and not such a scoop ......