US rates and the USD increased sharply on Friday night after stronger than expected payrolls led the market to scale back expectations of a 50bp Fed rate cut in July. US equities initially fell after the payrolls report, but bounced back to close only slightly lower on the day. Amidst the stronger USD, the NZD underperformed and fell almost 1%.
The non-farm payrolls report revealed 224k jobs growth in June, well above the market consensus of 160k, and much higher than May’s surprisingly low 72k print. The three month moving average of payrolls growth rose to 171k, lower than last year’s average of 223k, reflecting some slowing in the US economy, but still at a level that should, over time, keep the unemployment rate trending lower. The unemployment rate in June ticked up to 3.7% due to an increase in the participation rate while wages were slightly softer than expected.
The payrolls report eased market fears of a more abrupt slowdown in the US economy and Fed rate cut expectations were scaled back accordingly. The Fed is still widely expected to cut rates later this month given its recent messaging to the market, subdued inflation and softening in US and global activity indicators, but the probability attached to a 50bp rate cut in July has been significantly reduced. The market is now pricing 27bps for the Fed’s meeting later this month, down from 33bps prior to payrolls. The market prices 96bps of Fed rate cuts by the end of next year, down from 109bps previously. The 2 year US Treasury yield rose 10bps to 1.85%, while the 10 year yield rose 8bps to 2.03%, with both moving back into recent trading ranges. It will be interesting to see if Treasury yields can hold these gains tonight, as investor participation on Friday was lighter than usual after Independence Day.
While payrolls seems unlikely to be a game-changer for the market, it brought at least a temporary pause to the rapid decline in global rates; the 10 year yields on German bunds and UK gilts increased 3.5bps and 6bps respectively on Friday.
Equity markets initially reacted negatively to the prospect of less aggressive monetary stimulus from the Fed. S&P500 futures fell over 1% from their intraday highs, before recovering over the remainder of the session to close only 0.2% lower on the day. Defensive stocks, such as real estate and utilities, which have been the beneficiaries of the recent falls in rates (as investors turn their attention to dividend-based stocks as an alternative to lower yielding fixed income) were the underperformers on the day. In contrast, The KBW bank index was up 0.8%, with the prospect of less aggressive Fed easing perceived as more favourable for bank net interest margins.
Unsurprisingly, the USD got a boost from the payrolls release, and was up around 0.5% in index terms. Over the past fortnight, the USD appears to have found a short-term base, and the USD indices are now firmly back in mid-range territory. Trump meanwhile renewed his attack on the Fed, claiming the central bank “doesn’t have a clue” and accused it of having raised rates “too soon, too often.”
The Canadian dollar was the best performing currency within the G10, down only 0.2% against the USD, after the Canadian employment report showed a much stronger increase in wage growth. Canadian employment growth was flat on the month, but this followed six months of very strong gains. The market pared back its expectations of rate cuts by the Bank of Canada, but one remains fully-priced over the next 12 months.
The AUD fell 0.6%, to 0.6780, similar to the moves in the EUR, JPY and GBP. The 5.4% in iron ore futures in Singapore, after the China Iron and Steel Association asked regulators to investigate whether “non-market factors” were behind the recent rise in prices, didn’t seem to have much of an impact on the AUD. Also in Australia, on Friday, the government passed its Budget tax package through the Senate, which our NAB colleagues estimate equates to about 0.3% of annual GDP (although the boost to growth is likely to be a little less if households save part of the tax offset and some is spent on imports).
The NZD underperformed most of the G10 on Friday, and closed down 0.9%, at 0.6630, leaving it back in the lower-half of its trading range for 2019. In the domestic rates market, the 10 year swap rate fell 1bp on Friday, reaching a fresh record low of 1.715% (on a closing basis). NZ rates will open higher, and the curve steeper, today.
On the trade-front, White House Economic advisor Larry Kudlow confirmed that US and Chinese negotiators had recently restarted dialogue over the phone and that a face-to-face meeting was likely “at some point in the near future.” Whether the negotiators can find a solution to the difficult structural issues that remain between the two sides is another matter, and Kudlow cautioned there was “no timeline” to reach an agreement.
The focus in the week ahead is Powell’s semi-annual testimony to the House and Senate, on Wednesday and Thursday nights respectively. The Fed released its semi-annual monetary policy report to Congress on Friday, which reiterated that the central bank would “act as appropriate” to sustain the expansion. The market will be listening for any clues from Powell on the monetary policy outlook in light of the upside surprise to payrolls. Several other key Fed speakers are also out this week, including New York Fed President John Williams and Chicago Fed President Charles Evans, while the minutes to the June FOMC meeting are released on Wednesday night. The minutes to the ECB’s last Governing Council meeting are also released this week.