Markit’s Gavan Nolan wrote this CDS report
The monthly US non-farm payrolls report always has the potential to move markets. No matter that it is a lagging indicator; the state of the US labour market is an important gauge of the world’s largest economy and has knock-on effects on consumer confidence. Today’s report was typical in causing considerable volatility in spreads and stocks. A sell-off followed in the minutes after the release. The report showed 190,000 jobs had been lost in October, significantly more than the 175,000 consensus estimate. And the unemployment rate hit 10.2%, its highest rate in 26 years.
Credit spreads could be expected to endure a torrid session after such disappointing data. But the correction proved short-lived, with European Markit CDS indices closing only slightly wider and the Markit CDX IG trading tighter compared to yesterday’s close. What explains such a reaction? Some investors took solace in the fact that revisions to the August and September reports showed that 91,000 fewer jobs had been lost than previously thought.
But the jobs report was not the main event this week, and its secondary status also provides an explanation for today’s market reaction. It is no secret that the US economy is being propped up by massive fiscal and monetary stimulus. The Federal Reserve is providing the latter though near-zero interest rates and various unconventional measures, including asset purchases, liquidity support and financial guarantees. The length of time the Fed will provide the stimulus has preoccupied investors, causing volatility in financial markets across the globe.
Thus Wednesday’s policy announcement was crucial for spread direction. There was much debate over whether the Fed would remove the “extended period” from its statement, referring to the central bank’s willingness to keep rates at very low levels well into next year. In the run-up to the announcement the consensus seemed to be that there would be no change in the language. But Ben Bernanke has surprised the markets throughout his tenure, and mostly in a positive way. He delivered again this week by finding a “middle way”. The language became more nuanced, keeping the “extended period” but adding conditions on which the guidance was based: “low rates of resource utilisation, subdued inflation trends and stable inflation expectations”. Though the mention of inflation gave the hawks something to cling on to, the statement was interpreted by most as dovish and calming fears of a premature withdrawal of the stimulus.
The knowledge that the Fed is standing behind the economy helped support the markets today in a difficult session. Of course, the glut of liquidity provided by the Fed and other central banks is helping financial markets rally across the board. It will need a significant negative catalyst to divert investors from their chase for yield.
