Nonfarm payrolls data disappoints but markets look past that to another US fiscal stimulus. US 10yr close to 1%, commodities higher. Brexit talks down to wire amidst tentative signs of compromise

Market sentiment remains very positive.  Nonfarm payrolls were weaker than expected but this didn’t phase markets, which saw it as increasing the chances that another fiscal stimulus package is passed soon.  Equity markets rose to new highs, the US 10-year Treasury hit 0.98%, commodity prices rallied, and the USD downtrend continued.  The NZD took a breather, after hitting 0.71 on Friday morning, and is back down at around 0.7040.  Brexit talks are heading down to the wire.  

Markets remain inclined to see incoming developments with a ‘glass half full’ lens given pending vaccine distribution.  This was very much the case on Friday, with nonfarm payrolls surprising to the downside, but no more than a fleeting negative reaction across markets.  

Nonfarm payrolls growth in November was a disappointing 245k, lower than the 460k consensus and down on October’s 610k (revised from 638k).  The surge in Covid-19 cases in the US in recent months has evidently put the brakes on hiring in certain sectors, with retail seeing a net 35k job loss on the month and job growth in the leisure and hospitality sector falling from 270k to just 31k.  The unemployment rate fell to 6.7%, as expected, while average hourly earnings nudged up (but remains distorted by compositional effects).  

Markets saw the downside surprise to payrolls as increasing the chances that a bipartisan fiscal stimulus deal will be signed off before Christmas.  There has been more conciliatory talk from both senior Republicans and Democrats in recent days after a bipartisan group of lawmakers proposed a $908b stimulus package.  Senate Republican leader McConnell, who has been a roadblock to previous stimulus deals, is now “on board”, according to one of the senators who proposed the bill. Democrat leaders have said they are willing to accept the $908b figure, lower than their most recent $2.2tn proposal.  

On vaccines, Pfizer and BioNtech sought to allay concerns that supply-chain and logistical difficulties could hamper the distribution of their vaccine.  A WSJ report on Friday morning along these lines briefly hit risk assets. But the two companies said that they had made most of the 50m doses they had targeted by the end of the year and remained on track to produce 1.3 billion doses in 2021.  

It was ‘more of the same’ for markets on Friday, with broad-based gains across risk asset markets.  The S&P500 increased 0.9% to a fresh record high, with cyclical sectors (energy, materials and industrials) leading gains.  The small-cap Russell 2000 index outperformed again, rising 2.4%, with the market factoring in a better outlook for the domestic US economy and small and medium-sized businesses.   

Global rates pushed higher again, with the US 10-year Treasury yield closing in on 1%, a level that hasn’t been reached since the March crisis.  The 10-year yield was 6bps higher, finishing the week at 0.97%, while yield curves continued to steepen.  There was no change in 2-year yields, with the Fed still expected to remain on hold for the foreseeable future, but an 8bp rise in the US 30-year rate.  NZ rates were little changed on Friday but will open higher this morning after the overnight moves in Treasury yields.

Market-based inflation expectations continue to push higher as well, with the US 10-year ‘breakeven inflation’ rate rising 4bps, to 1.91%, its highest level since mid-2019.  The US 10-year breakeven inflation rate increased 16bps last week, driven by improving global growth prospects and higher commodity prices.  The 10-year breakeven inflation rate is now within sight of the 2% milestone that hasn’t been seen since late 2018.  

The increase in breakeven inflation last week was greater than the 13bp increase in 10-year US nominal yields meaning US real interest rates actually fell on the week.  That has undoubtedly been a factor in the continued weakness in the USD, which extended further on Friday, albeit only slightly.  The BBDXY USD index was down 0.1% on Friday, bringing its loss on the week to a chunky 1.1%.  Bouyant risk appetite (i.e. higher equity markets) and expectations for a broad-based global expansion next year are other factors behind the USD downtrend, alongside pre-existing concerns around the US ‘twin deficits.’  

The CAD was the clear outperformer on Friday, rising 0.6% to its highest level since mid-2018.  The Canadian employment report was stronger than expected, with the data revealing employment growth almost three-times the consensus and a sharp drop in the unemployment rate.  Higher oil prices were another tailwind for the CAD.  The EUR made a new post-2018 high intraday, before fading during the New York afternoon to close down 0.2% on the day.  The JPY underperformed, down 0.3%, consistent with the improvement in risk appetite and increase in US yields.  

Brexit talks look like they are heading right down to the wire.  According to Bloomberg, the key sticking point now appears to be the question of a “level playing field” (i.e. the extent to which the UK can deviate from EU regulations), with the two sides reportedly closer to an agreement on fishing rights.  The FT reported that there were signs of compromise on that issue of the level playing field, with France’s Europe minister suggesting that the UK might be allowed deviate somewhat from EU regulations but would face penalties if it went too far.  EU chief negotiator Barnier will report back on talks to the member states Monday morning (UK time) and UK PM Johnson and EC President von der Leyen will speak Monday night to judge whether there is a pathway to an agreement.  The GBP was only around 0.1% lower on Friday, suggesting that investors remain optimistic that the two sides can get a deal across the line, although time is fast running out.  

The NZD was the worst performing of the G10 currencies on Friday, falling 0.4%.  The NZD broke above 0.71 for the first time since April 2018 on Friday morning, before slipping lower over the remainder of the session to close the week around 0.7040.  The NZD underperformed on the week as well, rising only 0.3% despite broad-based USD weakness.  We see the NZD rising further over the next 18 months, having pencilled in a forecast of 0.73 (which in practice means a trading range extending to 0.75). There is clear upside risk to these estimates, with a good chance of these targets being realised a lot sooner than expected and a chance the NZD could hit 0.80 at some point over the next year or two.  

Fonterra announced on Friday that it had amended its 2020/21 milk price forecast range to $6.70 to $7.30, a narrowing from the previous range of $6.30 to $7.30.  We have raised our forecast payout from $6.80 to $7.00, which is the midpoint of Fonterra’s new range.  

Domestic NZ economic data continues to surprise to the upside, with building work in Q3 – an input to GDP – rising almost 35% over the quarter.  That puts the level of building work, seasonally adjusted, back up to where it was in Q4 2019 (i.e pre-COVID levels).  At this stage we have pencilled in a 14% quarterly increase in GDP for Q3, when the data is released late next week.   

Finally, OPEC+ has agreed to increase oil supply by 500,000 barrels per day (bpd) in January.  The cartel will make a monthly assessment going forward on whether to adjust supply further, up or down.  It said oil supply would be increased by a maximum of 2m bpd from present levels, with the maximum change from month-to-month limited to 500,000 bpd.  Brent crude oil rose 0.3% on Friday and 2.2% over the week, taking it to almost $50, its highest level since March.  

For the week ahead, the market will be watching US fiscal stimulus negotiations, Brexit talks and the ECB meeting on Thursday, where the central bank is expected to increase its bond buying programme by another €500b.