The consensus is for 70k — the central tendency of the distribution is 40k-110k with the fatter tails to the upside. The 70k is the lowest consensus expectation since October of last year. Citi does not have an official forecast but our economists’ 100k NFP forecast is very close to the consensus view.
With two year yields back down to 43bps, it looks as if the pain trade in fixed income is a stronger than expected outcome rather than a weaker. The question is how FX will react. In recent weeks it has been the case that good news for asset markets is bad news for the USD – if we regress EURUSD on rate spreads, Spain-Germany spreads and the S&P, the biggest factor by far has been the S&P in recent weeks. This doesn’t mean that the other factors have no impact but they may be so correlated with the S&P that independent effects do not emerge. In fact we also find that when we regress EURUSD on US and euro zone 2-yr rates independently, the coefficients on both the US rates and European rates are positive. Indeed, a simple regression of EURUSD on US rates show a positive coefficient, so there is extremely strong evidence over the last month that whatever has made asset markets more optimistic has led investors to buy EUR and sell USD. That has been the pattern over the last couple of years.
The question is whether that persists. My conjecture is that the correlation has been driven by the underlying policy response function in the US. Since early 2009, good US news has been driven by an aggressive policy response to the headwinds that US policymakers believed faced the US economy. Moreover, the US policy responses tended to occur in periods when foreign economies were not facing nearly as many headwinds as was the US. So, the US policy response was helping countries that did not need the help and put upward pressure on their rates structure.
Now the room for US monetary and fiscal expansion is limited, so any bounce in the US data is very unlikely to be anticipating QE3. If anything the risk may be that good US economic data would unwind some of the extreme dovishness that has been priced into the US rates structure in response to the weak data flow of recent months. Elsewhere, rate structures and asset prices reflect more optimism on growth and concerns on inflation. If we have a confluence of economic and asset market concerns abroad, and better than expected (even if not brilliant) US economic data domestically, the risk is that these correlations will shift.
It may be too early to invest based on the view that good news for the US is good news for the USD but investors should consider the possibility that positioning and market dynamics may be shifting. The trade below is an inexpensive way of putting a toe into the USD-upside water.
Macro Risk Index posts record decline
The unfavorable combination of slower than expected US growth, possible Greek default and breach of the US debt ceiling dominated market sentiment in June, leading to a rise in our risk aversion measures. Both our long and short-term Macro Risk Indices (Bloomberg ALLX MRI <GO>, Reuters CITIMRI) rose to elevated levels by 24 June, as prices of risk-sensitive assets came under pressure.
Despite most of the prior drivers of risk aversion still being unresolved, markets rapidly shifted into a positive mood last week. Our long-term Macro Risk Index reversed its two-month rise in five days, falling by a record 35.4% points between 24 June and 1 July. The short-term Macro Risk Index, which normalizes risk-sensitive asset prices relative to the past month, fell by 75.9% points over the same period, also a record.
The sharp reversal in risk aversion seems to be part of a new trend, where sentiment towards risk often changes quickly and violently. In Figure 1 and Figure 2 below we plot the levels and rolling standard deviations of daily changes of our Macro Risk Indices. To match the calculation windows of the indices, we use a rolling year for the long-term MRI and a month for the short-term MRI. Both Figures show that the Macro Risk Indices have become increasingly volatile, with recent moves exceeding the pre-2010 average by a factor of nearly two.
Last month’s 17% daily volatility of the short-term MRI is the highest on record, while the 4.8% daily vol of the long-term MRI in the last year is also close to an all-time high. This uncertain environment has proved negative for active FX trading and hedge funds. The Parker Blacktree Currency Managers Index (Bloomberg PBCIPCMI Index) shows that managers had the worst two-month performance in May and June, while the HFRX Global Hedge Fund Index (Bloomberg HFRXGL Index) shows that funds had the worst ever first half-year, losing on average 2.1% since the end of 2010.