The ‘reflation trade’ gathered momentum on Friday, with a disappointing nonfarm payrolls report seen as providing further ammunition for the Fed to keep monetary policy ultra-accommodative. The S&P500 made a fresh record high, US 10-year breakeven inflation rose above 2.5%, copper prices made an all-time high, and the USD weakened sharply. The NZD appreciated to a two-month high amidst a weaker USD backdrop, ending the week around 0.7280.
The monthly US nonfarm payrolls report was a shocker. Employment growth in April was just 266k, well below the 1 million consensus and even the lowest forecast of 700k. The unemployment rate unexpectedly ticked up, from 6% to 6.1%, in contrast to market expectations for a fall.
Explanations for the disappointing employment growth are varied. Many have pointed to the enhanced benefit payments those in unemployment currently receive (a $300 per week top-up on the standard unemployment payment), which means an estimated one-in-four are receiving more from staying at home than they would in employment, in turn discouraging labour force participation. Others, including some in the Biden administration, claim it relates to workers still not feeling comfortable about the health risks of returning to work and, given child-care facilities may still be shut, that some parents may need to stay home to take care of their children. There is also the possibility that this was just a ‘rogue’ data print, with most economists expecting substantial job gains in the months ahead.
Either way, the evidence is strong that this appears to be an issue with constrained supply of labour, rather than an issue with labour demand. Job openings in the US are at a record high. And wage growth surged in April (+0.7% on the month), with unusually large increases for leisure and hospitality workers (+1.6% on the month), consistent with employers having to ‘pay up’ to get workers on board.
The market interpreted the data as suggesting the Fed will maintain ultra-easy monetary conditions for even longer, with pricing of the Fed’s first hike pushed back from Q1 to Q2 2023. The yield curve aggressively steepened, with a 4bp fall in the US 5-year rate contrasting with a 5bp increase in the 30-year rate. The 10-year rate was 1bp higher on the day, at 1.58%, having been as much as 10bps lower at one point.
While the Fed might claim that current inflation pressures are Inflation are transitory, market participants appear to be growing more worried. The US 10-year breakeven inflation rate jumped 5bps, rising above 2.50% for the first time since 2013. Stable 10-year nominal rates and higher breakeven inflation mean US real rates continue to push lower, down to -0.93% for 10 years.
Equity markets headed higher on Friday post the payrolls report. The main US equity indices were up 0.7-0.9%, with the S&P500 and Dow Jones hitting fresh all-time highs, while the Eurostoxx 600 gained 0.9%, reaching a new record high of its own. Ultra-low US real interest rates and expectations for a turbocharged global economic expansion remain supportive drivers of equity markets.
Likewise, commodity prices continue to surge higher. A day after iron ore reached a record high, above $200/tonne, copper prices rose over 3%, exceeding their previous all-time high from 2011. Oil prices were up modestly on Friday, but 2% higher on the week.
In currencies, the USD declined sharply, with the Bloomberg USD index falling 0.7% on Friday, its biggest one day fall since early December. The Bloomberg USD index is trading at its lowest level since early January and is almost at a three-year low. It’s worth highlighting that the USD’s renewed downtrend since the end of March – some 3% on a BBDXY basis – has coincided with the 30bp fall in the US 10-year real yield over that time.
The EUR and AUD both gained 0.8% on Friday, with the latter breaking through resistance at 0.78 to close the week around 0.7845. The JPY underperformed (+0.45%) amidst the risk-on backdrop, although it was still higher on the day. The CAD was the weakest of the G-10 currencies, rising just 0.1% after a soft Canadian employment report (although this followed two exceptionally strong releases).
The NZD pushed up to almost 0.73 on Friday amidst the weaker USD, higher commodity prices and risk-on backdrop. It eventually settled back at around 0.7280 by the close of trading, its highest close since early March. The NZD outperformed last week, gaining 1.6%, a similar sized gain as the AUD.
In domestic data, the RBNZ’s 2-year ahead inflation expectations series moved up to 2.05% in Q2, from 1.89% previously. Inflation expectations are slightly above the 2% midpoint of the RBNZ’s 1-3% target range for the first time since mid-2019. It’s a tick in the box for New Zealand CPI remaining sustainably at 2%, one of the conditions the RBNZ is looking to meet before it considers withdrawing monetary stimulus.
Short-end domestic wholesale rates continue to grind higher on Friday, with the 2-year swap rate rising 2bps to 0.52%. Besides the market slightly bringing forward the expected timing of RBNZ OCR hikes, after the NZ labour market report last week, the 90-day bank bill rate has also been edging higher over recent weeks, providing some additional upward pressure on short-end swap rates. The 10-year swap rate was little changed on Friday, at 1.88%.
In news over the weekend, Scottish National Party leader Nicola Sturgeon said the weekend’s Scottish election results represented a mandate for another referendum on independence from the UK. The SNP fell just short of an overall majority, but a stronger than anticipated performance by the independence-supporting Scottish Green party means there is a majority for another referendum in the Scottish parliament. The UK government still needs to agree to a referendum and PM Johnson has indicated in the past that he won’t do so. The GBP may come under some short-term pressure this morning although, with the SNP saying their immediate focus is securing the recovery from Covid-19 and the UK government likely to resist SNP wishes for a referendum, we suspect the market will move onto other drivers before long.
It’s a quiet week ahead domestically with only second-tier economic data released. In the US, the focus will be on the CPI release on Wednesday night amidst growing inflation concerns among market participants, while another bumper retail sales release is expected on Friday. On US fiscal negotiations, Biden is due to meet with Republican and Democratic leaders on Wednesday.