World view under normalizationThe U.S. Department of Labor just released the jobs report for October and the number was unexpectedly off the charts.  America added 271,000 jobs for the month and the unemployment rate dropped to 5%.  That being said, there are still almost one hundred million people permanently out of the work force, but still, the October number was impressive.  

What does this mean?  What are the consequences for the American economy and the world?  The bond market is answering this question for us as the yield on the 2 year note is above 0.9% as I write this.  In other words, interest rates across the yield curve in the United States are going higher!  This will have consequences in several areas.

First of all, it will keep the U.S. Dollar king.  Higher rates offers a better return for investors in American debt.  This will increase demand for the greenback and push the bid higher against other currencies.  The one caveat here is that the Middle East is becoming more and more volatile, where the world still gets forty percent of its oil.  Although many nations are trying to kill the petrodollar relationship to the price for crude, it still very much exists.  A larger conflict in the Middle East, threatening oil supplies, say between Iran and Israel, would for sure spike crude prices to much higher levels.  This would put downward pressure on the dollar, so keep that in the back of your mind.  Absent this type of scenario, a stronger dollar could keep commodity prices across the board under pressure, that is until global growth catches up with the United States and demand for commodities strengthens.

As far as the equity markets are concerned, expect significant volatility to continue.  We’ve had a really good run over the last few weeks as markets seem to have decided that bad news was good news and the Fed wouldn’t be increasing rates anytime soon.  This glass house was just shattered.  I would guess we will see a retrenchment of those gains in the near term.  Eventually, equities will start to price in future profit gains from a strengthened economy but first they have to absorb higher financing costs that are sure to follow the bond market and Fed moves coming down the pike.  

That being said, I don’t see how the Federal Reserve cannot raise short term rates in December.  If they don’t, they open themselves up to charges they are even more political than they have already been accused of being.  The firming labor market will eventually push up inflation.  There is still a LOT of slack in the economy but this jobs report is the canary in the coal mine.  Rates are moving higher and soon.  

Higher rates will also put pressure on Congress and the Administration to do something finally about America’s runaway spending and debt crisis.  Entitlements are the big elephant in the room and have to be dealt with.  Paul Ryan, as the new speaker of the house, has the inclination to do so.  Doing something about the debt would give the world comfort that the U.S. is serious about paying its bills going forward, and more importantly, will have the will to do so.  

If Obama was smart, he could help out the Democrat’s 2016 election chances by forging a deal with Congressman Ryan, a bipartisan blueprint to get America solvent.  
But, that’s a topic for another column.  

L. Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience.  He is also an author of historical fiction thriller novels.  His first of several books, Currency, deals with the consequences of overwhelming sovereign debt.  He is a contributor to many media outlets and is a foreign correspondent for Newsmax TV.


World view under normalization