Forget the Fed and watch the dollar
U.S. equities climbed to new highs for 2016 on Monday thanks to, according to the conventional wisdom, comments from Federal Reserve Chair Janet Yellen as she responded to Friday's surprisingly weak jobs report.
Yet she hardly sounded a triumphantly dovish note. She said the U.S. economy on balance appears strong and that policy normalization would continue at a gradual pace. She also labeled the May payroll number "disappointing" and failed to say that another rate hike would be appropriate "in coming months" as she did on May 27.
Other officials sounded a more hawkish note -- as had been the norm until last Friday's jobs numbers -- with St. Louis Fed President James Bullard and Atlanta Fed President Dennis Lockhart both suggesting a July rate hike was still a possibility.
Instead, the main catalyst for the stock market's latest strength seems to be the newfound weakness in the U.S. dollar, which is boosting everything from oil prices to energy stocks and emerging market exchange-traded funds (ETFs).
The move started on Friday, as the currency market responded to May payroll report before Yellen even had a chance to speak, believing that the weakest pace of job gains in six years will force a rate hike delay.
Watch for this dynamic (markets responding to the dollar's undulations) to continue as Fed officials enter a media blackout period ahead of their policy meeting later this month. The futures market has basically priced out the odds of any Fed hikes in June or July, pushing any possible action until the end of the year. CME Fed fund futures put the odds of a July hike at only 23 percent.
The next insight into the health of the job market will come on Wednesday when the Job Openings and Labor Turnover Survey (JOLTS) is released, which is one of Yellen's favorite data points. If openings remain strong, as is expected, watch for the June/July rate hike odds to rebound and stocks to struggle as the U.S. dollar resumes its recent strength.
Wall Street analysts remain bullish on the dollar and the labor market.
Ed Yardeni of Yardeni Research, in a note to clients on Monday, wondered if May's weak payroll gains were more about a shortage of skilled workers rather than a shortage of jobs. This is based on near-record job openings, a solid private-sector ADP payroll report, upbeat consumer confidence and evidence of wage inflation as companies are forced to lift pay to attract the workers they need. Wednesday's JOLTS report could confirm this thesis.
The team at Capital Economics believes the market isn't paying attention to evidence that the Fed is falling behind the curve as inflation antecedents accumulate. They expect a more aggressive pace of rate hikes heading into 2017, which will further bolster the dollar. Goldman Sachs is recommending clients keep an eye on the dollar, especially in relation to the Chinese yuan.
For investors keeping track at home: For clues on where stocks are going next, set Yellen's vague verbiage aside and watch the greenback instead.
