The jobs report turned the market hard on Friday. A 2 big figure gain on the Euro and $50 on the gold price tells it all. Based on the employment data it is very hard to believe that US interest rates can remain at zero for much longer. But that is exactly what is going to happen. The carry trade is alive and well and will resurface as a dominant market factor. It is just going to take a bit for the power of zero cost debt to start driving the money flows.



My totally non blue chip economic forecast for GDP goes as follows:



4th Q 2009 = 4%

1st Q 2010 = 4.5%!!

2nd Q 2010 = 2.5%

3rd Q 2010 = 1%

4th Q 2010 = 0%



These numbers are not too far from the thinking at Goldman. They see things chugging along and then slowing. My numbers are more extreme then theirs for end of 2010. My guess is that we are going to hit a wall sometime around mid-year. By then most of the monetary and fiscal stimulus will be gone. Without the oxygen we are are going to stall.



Bernanke has stuck to his guns and set out a timetable for the end of the Agency purchases as “March”. This certainly means that there will be no increase in the Funds target until at least then. After that it gets a bit murky. The Fed Funds Futures closed Friday at levels that I think are a pretty reasonable assessment of what might happen. My read on what those numbers say:



-It is a pretty decent bet (70-30) that the Funds rate will be increased 25BP by June.



-It is almost certain that the Funds target will go up 25BP by August of 2009.



Let’s say that that is wrong. Take a scenario with a more extreme outcome than suggested by the futures market. Assume Ben shows his muscle and tightens the Funds rate by a whopping 50BP by September 1st. Who cares? That is nothing.



So now it is September 2010, the economy is again clearly decelerating. Unemployment will be at best 9%. Does anyone think that Bernanke will increase rates by more than 50BP given the economic backdrop that he will be looking at? Not a chance.



When people get to understand that this low rate environment is going to be with us for a long time, the seduction of the carry trade will again be the dominant theme.



The price action on Friday killed the leveraged players. I talked with a lady on Friday night. She runs big money in liquid macro trades. She got beat up. She said,



“ The carry trade is like an orchid. It looks beautiful, but when you get too close it smells like rotting meat”.



The rest of the conversation was about timing and entry points to put the trade back on. Nothing has changed.