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BMO: Market Participants “Flummoxed” By What’s Going On

Courtesy of ZeroHedge View original post here.

First, a quick reminder of how the US officially entered the second Great Depression on May 8 courtesy of BMO:

NFP revealed total job losses of -20.5 million; remarkably close to the -22 million forecast and well above the -870k prior. The Unemployment Rate gained to 14.7% from 4.4% Mar and was shy of the 16.0% anticipated. The BLS added that had those who were employed but absent from work been counted in UNR, the figure would have been almost 5 percentage points higher. Average Hourly Earnings gained 4.7% MoM vs. +0.5% prior — the spike in AHE and weekly hours is due to compositional effects more than anything else; i.e. the domestic workforce didn't get a 4.7% pay raise last month. The participation rate dropped to 60.2% the lowest since Jan 1973. Overall, a dismal report which has in line with expectations and therefore not likely to trigger any large price action.

The market's reaction to the worst jobs report onn record? Futures spiked because the 20.5 million number "was not as bad" as the 22 million expected. No really: and that's what happens when you put the algos in charge who have zero concept of scale or context.

And as BMO's Ian Lyngen and Jon Hill writes, "today’s session is setting up to be one that further extends the divergence between financial markets and incoming economic data. Equity futures are pointing toward a strong open with 2900 in the S&P 500 already achieved, and prospects are improving for a run at 3000, a level that was inconceivable just a month ago" with the backdrop of an April employment report showing over 20 million job losses "illustrates this disconnect that has market participants flummoxed."

Why are stocks now completely disconnected from any fundamentals? Simple: the Fed.

As BMO puts it, a reversal of March’s stock loses and record low 2-year yields (touched 11.3 bp overnight) reflect the same overarching dynamic – investors’ expectations for the Fed to retain an extraordinarily accommodative monetary policy stance for the foreseeable future and the eventual result of Powell’s efforts will be constructive for the real economy.

Meanwhile, as the Canadian bank notes, "the essence of the debate is one of timing; as is often the case with differing forecasts based on the same set of facts. A second Covid-19 wave is widely anticipated, but not one which leads to the reinstatement of lockdown orders; if this comes to fruition, dip-buying in risk assets could very well prove justified. The flipside is a resurgence of the coronavirus that results in another halt of the domestic economy – the ramifications for future consumption patterns, the stability of the banking system, and even basic services would be dire; if for no other reason than the bar for another shutdown is presumably very high. Moreover, the experiences of regions in Asia and Europe that have been reopened for longer bolsters confidence in ability of the US to avoid a severe second wave."

We present the rest of the BMO note below, but the gist is clear: the market is going all in a happy ending… and if the market is wrong and stocks crash, well the Fed will become stock buyer of last resort, while also pushing rates negative just to make sure. And that's why stocks are now higher than where they were a year ago when the US was not in a second great depression.

Given this context, the question quickly becomes: how much does this morning’s NFP matter for refining market participants’ expectations for the forward path of rates and the real economy? On a scale of 1-10, we’d give it a C-. Not that there will be no informational content in the BLS’s official numbers as setting the ‘all time low’ for job losses is in and of itself level-setting, rather that the severity of the weakness has no applicable reference. In a valiant attempt to offer perspective, BBG posted this headline “April Layoffs to Test Total of Last Nine Recessions.” What if it was just the last three recessions? The simple fact so much damage is being done to the labor force in such a condensed period of time is what makes this episode so unique and incomparable to any that have come before.

How then should one expect the market to trade the headline NFP; with a great deal of skepticism. The difference between 25 million job losses and 20 million is very meaningful to 5 million workers; however, it’s less clear the market has an ability to accurately calculate the implications for forward expectations on the pace and shape of the recovery. Adding yet another wrinkle into the interpretation of the employment data are reports that firms are struggling to lure workers back given that the enhancements to unemployment benefits via the CARES Act have made not working more profitable. Yes, eventually the weekly payments run out; although with a national average of 39 weeks, sidelined employees might lack the urgency to return to the old 9-to-5 that investors are assuming will spike NFP in the second half of 2020.

Using this week’s price action thus far as a guide, the biggest drivers have been the reality of ballooning Treasury issuance which has steepened the curve and the specter of negative policy rates in 2021 that has led the belly to outperform while pushing 2-year yields to record lows. This trend toward a steeper curve will remain thematic going forward and although the inflationary risks created by the massive efforts to stimulate the real economy have yet to truly buoy breakevens (10s are at 109 bp this morning), once the lockdowns thaw and the ‘new normal’ simply becomes the normal, the second leg of the steepener takes hold. This shift in sentiment will occur long before the inflation data demonstrates an upward basis, even if it’s evidently still ‘too soon’ given the ongoing deflation chatter making the rounds.

As a brief recap, a record-setting negative NFP read would otherwise imply a dramatic price reaction across financial markets is in the offing. Alas, the well telegraphed Covid hit to the labor force is well known at this stage – a dynamic reflected in this month’s pre-payrolls survey. Should the market rally after the release 5% would buy, 54% would do nothing and 41% would sell; all within striking distance of recent averages. Conversely, a downtrade would be met with a bid 46% of the time versus a 47% average which reinforces the equilibrium trading environment in which investors find themselves. Finally, if there was a takeaway to be gleaned from the outlook on the belly, it is ‘reply hazy, try again’ as 31% were unsure on the direction of 5-year yields from here, well above the 18% average and the highest since April 2017.

With the only economic unknown of relevance now the recovery from the pandemic-driven recession, our first special question provided valuable insight on when ‘temporary’ job losses will be viewed as ‘permanent’. There was a wide range of responses from 1 month to 5 years, however most focused on a timeline slightly shy of an additional year before those jobs lost would be viewed as not coming back in their past form. The mean answer was 11 months and the median was 10. In practical terms, this delays the ultimate process of evaluating the speed with which the economy will recover, and thus how quickly asset prices will respond. There is also the nuance of what variety of employment returns and when, and while unknowable at this stage, will be a critical variable in judging how quickly spending, and thus inflation makes its way back into the system.

Timing horizon was the most frequent caveat given to our second special question on how inflation will ultimately evolve as the pandemic fades. Indeed, an initial period of deflation followed by a building of price pressures was a commonly offered write in. Nonetheless, 62% are of the mind the efforts out of Washington will stoke inflation, with 38% seeing deflation as the most likely outcome of Covid-19. The effectiveness of the Fed and Congress’s efforts will continue to be top of mind, and while a period of low inflation is certainly upon us, we eventually think the firming of expectations will translate to a steeper curve over the medium term.

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