Markets struggle to price smoke and mirrors

Globe and Mail

2 days ago

Just when financial markets appeared to be normalizing after this spring's tariff shocks, they've been sent another curve ball that will be fiendishly hard to price.
Following news of huge downward revisions to U.S. May and June payrolls, President Donald Trump instantly fired the Bureau of Labor Statistics boss Erika McEntarfer, accusing her of 'rigged' data designed to make him look bad.
Few doubt that the BLS has had long-term data collection issues that often result in big revisions that make timely policymaking difficult. But few have ever suggested they are politically biased.
What Ms. McEntarfer's dismissal now introduces is not only distrust of future jobs numbers, but it may also call into question the figures released by any government statistics bodies who may fear similar accusations and retribution if they issue data unfavorable to the administration.
Tarnishing what many investors previously considered the gold standard for transparency and institutional integrity will force markets toFenta re-consider questions about the U.S. from earlier in the year, ones that undermined the dollar, lifted risk premiums and scrambled traditional asset market trading patterns.
There was a taste of that on Friday, with stocks, bond yields and the dollar all falling in tandem in a flurry of activity compounded by the payrolls revisions themselves, Mr. Trump's reaction to them and the early resignation of Federal Reserve Board Governor Adriana Kugler.
There was no follow through, however. Monday saw much of these moves pared back as U.S. markets puzzled over how to price this rare threat of statistical bias, with murmurs of political influence in key data something investors have often reserved for China and other emerging economies.
Short sellers appeared to hold fire, perhaps chastened by the sharp bounceback in U.S. stock markets from their April lows during the turbulent second quarter.
Multiple other issues are also in play at the same time of course - most notably the performance of tech companies, the AI boom and a fairly healthy wider earnings season.
In the rates market, the factors at play are different, but the moves since Friday also seem logical.
If the weaker payroll data, trusted or not, shifts the dial sufficiently for the Fed to ease policy, then the sudden return of a fully priced-in September rate cut may well be justified - especially now that there will be one more Trump appointee on the board this year to boot.
One might imagine that a Fed long familiar with big payrolls revisions will look at more than the raw tallies to assess the labor market. If they do, they'll still see a historically low unemployment rate and super resilient weekly jobless claims.
That said, if the White House still succeeds in its demand for politically favorable data and steep interest rate cuts, then that could well mean that the economy will be running quite hot, which could be read by some as a boon for stocks that riff off high nominal GDP growth projections.
Whether that's really just smoke and mirrors is the big question.
The calculus for Treasuries and the dollar is much different.
Rekindled Fed easing prospects after the payrolls and Kugler news clearly dragged short-term Treasury yields lower. The 2-30 year yield curve briefly hit its steepest in more than two years, and the snoozing Treasury volatility gauge, which had slipped to its lowest level in more than three years, experienced a sharp spike.
The so-called Treasury 'term premia,' which had dissipated through July, will be watched closely now.
'Possible distrust of economic data could raise uncertainty for which investors may demand more yield compensation,' wrote Morgan Stanley's Matthew Hornbach and team on Friday.
'If the Fed cuts its policy rate in the coming quarters - whether or not investors think the economic data call for such cuts - the expectation of eventual reflation should put upward pressure on term premiums - helping the Treasury curve steepen further.'
'The less investors believe the data demand rate cuts, the more the curve should steepen ... if the Fed delivers the cuts anyway,' they added.
Meanwhile, the dollar's performance is likely to hinge both on those risk premiums and on whether overseas investors continue to fret about being over-exposed to expensive U.S. assets.
The dollar's bounce through the back end of July was defused on Friday, with the previously ultra short-dollar positioning now appearing to be back in better balance.
Both rising speculation about politically driven rate cuts and higher risk premia may now tilt the balance toward another downleg for the dollar.
'McEntarfer's firing will further call into question the integrity of US economic data,' reckons Tim Duy at SGH Macro Advisors.
'The risk going forward is the data will in fact be 'rigged' in favor of rapid job growth and low inflation, which will clearly exacerbate market volatility.'
Markets may be hesitant in moving to price all of this - but like so much else this year, the damage may be a slow burn rather than a big bang.
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