As the calendar flips to June, no data point looms larger than Friday’s payrolls report. It’s a thin calendar for economic reports and earnings this week anyway, and that means the jobs data will be subject to more scrutiny than usual. Investors will lean on the marquee report for proof that recent strength in both stocks and bonds has been justified. Or, is it possible that this report will bring the volatility needed to shake up the broad indexes one way or the other?
ADP, a payrolls processing firm, offers a teaser peek at May jobs growth with a private-sector hiring tally issued Wednesday morning. Then, weekly jobless claims are due for release Thursday morning, all leading up to Friday’s pre-bell release from the Labor Department.
Government data is expected to show that the U.S. economy added around 200,000 jobs in May, fading from the 288,000 April payrolls add, according to industry economists (see the week’s full economic calendar in figure 3, below). February and March numbers were also revised higher at that time. Each month, it’s important to look at all revisions and get a sense of the multi-month trend in hiring—not just the peaks and valleys of a single month.
Meanwhile, investors across the pond will be focused on major policy decisions from the European Central Bank and the Bank of England on Thursday. Indeed, low interest rates on the other side of the Atlantic seem to be one reason why U.S. Treasury yields have declined relentlessly year to date. The rate on the benchmark 10-year note recently hit 10-month lows near 2.4%, down from the 3% hit at the end of 2013 and well off the 3% to 3.5% target that most economists predicted for 2014. Many technicians point to a 2.35% level as next major support.
Simply put, although Treasury bond yields are low, they are still relatively attractive compared to government debt in developed economies outside of the U.S. Therefore, any unexpected uptick in yields in economic giant Germany or other euro-zone nations could impact yields in the U.S. as well, and any signs that European rates will remain ultra-low for much longer than their U.S. equivalents will have the opposite effect.
While bonds have been bid, the S&P 500 strengthened in May as well (so much for normal stock-bond correlation). Buoyed by lower interest rates and expectations for an economic recovery in Q2, the index gained nearly 2% for the month and moved to new record highs last month. At the same time, the CBOE Volatility Index (VIX), which tracks the implied volatility priced into S&P 500 index options, fell to 54-week lows of 11.36 last week. The index is now a far cry from the 2014 high of 21.44 set in early February (figure 1). VIX seems to have found a support level at 11.35, but I don’t think anyone is taking anything for granted with the index.
Some market watchers worry that the recent drop in VIX is a sign that investors have become too bullish or complacent. VIX is sometimes called the market’s “fear gauge” because it tends to spike during market sell-offs when portfolio managers and other investors scramble to buy puts on the S&P 500 to hedge stock positions. The index fell to its lowest levels since March 2013 last week, and doesn’t seem to be reflecting investor fear, angst, or anxiety at all. That poses the bigger question: is the apparent unplugging of VIX itself a sign of a market operating on borrowed time?
Looking at longer-dated S&P 500 index options paints a slightly different story. The Chicago Board Options Exchange posts the term structure of VIX options daily on its website. The graph (shown from May 29 in figure 2) depicts implied volatility of SPX options across different expiration months. For example, while July options have volatility of only 12, that figure increases to more than 18 in the December 2015 options.
In other words, VIX is a measure of short-term risk perceptions, but the relatively steep term structure across later expiration months reflects a stronger view of future volatility.
What’s it Gonna Take?
Last week’s GDP report showed the U.S. economy contracting at a 1% annualized rate in Q1, in large part because poor weather slowed demand and businesses cut exports and inventories. Consumer spending, a key piece of the report, showed improvement. Still, with such a disappointing headline GDP reading, it surprised some market observers when Wall Street brushed off the report on its way to a new stock market record.
Now, looking ahead, consensus estimates are calling for a sharp 3.5% increase in Q2 GDP. That hope for a dramatic turnaround, and continued low rates, are the drivers for the stock market and what’s keeping a lid on short-term volatility. The question this week: Can Friday’s pivotal jobs report live up to this Goldilocks scenario?
Good trading, JJ @TDAJJKinahan