Yesterday I stumbled upon this great tweet by Joseph Weisenthal that highlighted the relationship between the US NFIB Business Compensation Plans versus ECI Private Sector Wages.
There are lots of signs that we should soon start to see some wage acceleration – this chart is not groundbreaking by any means. But what I found most interesting was the comment stream from the tweet. Instead of just accepting that the odds favour this relationship holding up, a lot of commentators were more interested in explaining why it isn’t going to work this time.
Although I understand their skepticism – it has after all been more than a decade since we have experienced any decent wage growth, I still find their pessimism telling as a market gauge.
Ever since the credit crisis of 2007 the economy has disappointed. Even as the Federal Reserve has thrown unprecedented amounts of liquidity into the system, the recovery has been subpar. The average American has struggled over these past half dozen years. No matter how high the stock market has risen, it hasn’t seem to translate into an improvement for Main Street.
Given this terrible outcome – higher financial assets prices making the rich even more wealthy while the middle and lower class struggle, it is obvious why the commentators are skeptical that it will ever change.
But this is where I think markets often do a poor job of discounting the future. The tendency of market participants to fall prey to recency bias is a story that is played on an endless loop. Time and time again, the markets seem to be only capable of taking the immediate past and extrapolating it into the future.
So it is no surprise that many market commentators think the relationship above will break down. How could wages go up? They haven’t been going up for the last decade, so why are they going to start now?
Don’t get me wrong – right now I too am at a loss to explain how we are going to get wage growth. The world economy seems to be rolling over. There doesn’t seem to be any signs of growth anywhere.
But that outcome is most likely fully priced into the markets. There are few that are expecting the relationship above to hold up. If somehow the world growth stabilizes and manages to turn back up, then there is a good chance that wage growth will surprise to the upside.
At that point the markets will be way behind the curve. Now from there I think it will get more complicated because Yellen’s gift to the lower and middle class is going to be lower rates for longer, but the bond market is priced for perpetually low inflation. Any deviation from that script is going to cause a large repricing lower.
I am not yet betting on this outcome, but I am watchful for the signs that global growth has stopped falling. At that point, the US bond market is going to offer a very tempting short opportunity. After all, even though the relationship that Joseph Weisenthal has highlighted above has held up for 30 years, pretty well everyone believes that this time is different… And we all know… it never is…
Shorting more EURJPY
I continue to add to my short EURJPY trade. Europe simply can’t afford to have their currency rising so strongly against the Yen.
Right now I know that everyone is all beared up on the Yen. I know, I know – it can only go down. And I know that the ECB is a continual disappointment when it comes to expanding their balance sheet.
But here is a thought; what if the Yen has hit a point where it is making the Bank of Japan nervous? What if the heat they take behind closed doors at the G20 meeting forces them to issue some words of warning to the FX market? What is going to happen to all these newly minted Yen shorts then? And what about Europe? What if the Lew comments about the potential for a lost decade finally wake them up to the severity of the situation? Maybe the pressure to expand their balance sheet is going to give them political cover to be good global citizens. Either way, in my mind the risks are that the EURJPY heads lower, not higher. If it continues to rise, then it will only make the ensuing Central Bank reaction all the greater. Shorting EURJPY is scary, but I think it is the right trade. I am adding to it.