A 'goldilocks' nonfarm payrolls report - strong job growth, higher labour force participation, some moderation in wage pressures. US rates come down, with the market now seeing just over a 50% chance of a 75bps Fed hike later this month

Friday saw some relief for the global bond market after a ‘goldilocks’ nonfarm payrolls report which showed some moderation in wage pressure and a surprise increase in the unemployment rate.  US bond rates were as much as 11bps lower, with market pricing for a 75bps hike at the Fed’s upcoming meeting swinging back closer to 50%.  The other key news was that gas flows through the Nord Stream 1 pipeline would be suspended indefinitely, allegedly due to newfound technical issues.  This saw equity markets and the EUR give up earlier gains, the S&P500 closing 1.1% lower and the EUR ending the week back below parity.  The NZD printed a fresh 2-year low on Friday but recovered to end the week just above 0.61.

The nonfarm payrolls report showed the US created 315k net new jobs in August, very close to market expectations, although there were downward revisions of 107k to the prior two months.  The trend in job growth has clearly slowed from earlier in the year but the 315k monthly job gain is still a very robust pace.  The unemployment rate increased from a 50-year low of 3.5% to 3.7% but this was a ‘good news’ story as it was caused by an unexpected increased in the labour force participation rate from 62.1% to 62.4%.  The increase in the participation rate might provide some tentative (and very welcome) signs that labour supply is starting to increase, which would help ease some of the intense tightness in the labour market.  Also encouragingly, wage growth came in lower than expected, although with average hourly earnings growth still running north of 5% over the past 12 months, the Fed will need to see further moderation to be confident it is on track to hit its inflation target.

So, while the Fed (and the market) shouldn’t get carried away with one economic data release (especially one that can be subsequently revised, as payrolls often is), this was a ‘goldilocks’ report in many ways, with still-strong job growth, some evidence of workers returning to the labour market, and some moderation in wage growth.  Certainly, the initial market reaction was consistent with investors seeing the Fed as having a little more latitude to raise interest rates somewhat less aggressively.  The market has pared back the probability of a 75bps hike by the Fed later this month from around 75% to now closer to 50% and has scaled back the expected peak in the cycle from close to 4% to now around 3.85%.  This won’t be the final word on what the Fed does with the cash rate in September however – the CPI release next week is likely to be key in influencing market expectations ahead of that meeting.

US rates were lower across the curve, led by the 2 to 5-year maturities (both around 11bps lower) with the 10-year rate down a lesser 6bps, to 3.19%.  The curve steepening is consistent with investors perceiving a slightly higher chance that the Fed won’t need to crush the economy to achieve its inflation objectives.  But with the 2y10y yield curve still deeply inverted, at -21bps, history would suggest a recession next year is still the most likely outcome.

The other key event on Friday was the announcement from Gazprom that gas flows to Europe through the Nord Stream 1 pipeline would not resume after the end to the three-day maintenance period.  The indefinite suspension of gas flows through the pipeline, which have only been running at around 20% of capacity, is allegedly due to another problem with the turbine, although most think it is another example of Putin trying to inflict further economic damage on the European economy as punishment for sanctions.  Gas storage levels have been increasing in Europe ahead of winter, and last week reached the 80% target earlier than expected, but there are still doubts around whether the region can get through a colder-than-normal winter without demand cuts (including, at the extreme, power rationing).  European energy ministers are set to meet at an emergency meeting this Friday night to discuss the crisis with a range of measures reportedly on the table, including formalising measures to cut demand and cap the price of non-gas power prices.

Over the weekend, Germany announced a €65b (~2%/GDP) support package for businesses and consumers.  Meanwhile, Sweden and Finland announced liquidity and credit guarantee measures for power companies, many of which are struggling to post collateral as margin on derivative contracts.

Equity markets took the payrolls report positively, with the S&P500 up as much as 1.3% in the New York morning and European stocks closing more than 2% higher on the session, but the positive vibes didn’t last long, with the Gazprom announcement sparking an abrupt turnaround.  The S&P500 closed just over 1% lower on Friday, leaving it down more than 3% on the week, while the NASDAQ was off 1.3%.  The European cash market was closed at the time of the Gazprom announcement, but equity futures point to around a 2.5% decline in the EuroStoxx 600 when trading reopens tonight while gas futures and wholesale electricity prices are set to spike higher again, exacerbating the stagflationary backdrop in Europe.

Also not helping the mood were concerns that the Chinese tech hub of Shenzhen, with a population of around 18 million, might follow Changdu into lockdown.  Photos show supermarket shelves in the city cleaned out as residents braced for a sudden lockdown.  Over the weekend, the authorities have locked down the city centre, including public transport, and conducted mass testing of the population after the city reported 87 cases on Friday.  The Chinese zero-Covid approach continues to hamper the global growth outlook while also disrupting global supply chains.

Like the equity market, currencies were whipsawed around by the payrolls report and Gazprom announcement.  The initial market reaction to payrolls saw the USD weaken sharply, in line with the pullback in Fed rate hike expectations.  The BBDXY USD index, which hit an 18-year high on Thursday night, was down as much as 0.6% at one point.  But this then reversed after the Gazprom announcement, with a sharp fall in the EUR – from around 1.0030 to around 0.9950 – leading to a recovery in the USD.  Ominously, USD/JPY was little changed on Friday despite the pullback in US rates, ending the week above the 140 level.  The market has its sights on the 1998 highs in USD/JPY, around 147.  Elsewhere, the PBOC set its daily yuan fix at a stronger-than-expected level for the eighth day in a row, helping USD/CNY stabilise around the 6.90 mark on Friday.  The NZD made new a fresh two-year low on Friday afternoon, just above 0.6050, before recovering in the overnight session to end the week just above 0.61.

In news over the weekend, the G7 have agreed on a price cap for Russian oil imports.  Countries will only be able to access shipping and insurance from G7 countries if they abide by the oil price cap, which has not yet been set.  Analysts are cautious about its chances of having a major impact without the unlikely participation of big oil importers India and China.  In other oil-related news, OPEC+ meets tonight to decide on supply, with most analysts expecting no change to production levels.  The WSJ reported over the weekend that Russia was opposed to a production cut.  Brent crude oil prices were up around 1% on Friday but are still trading close to their lowest levels since February, just above $93.

Friday saw a sharp reversal in domestic wholesale rates in thin and illiquid trading conditions.  The 2-year swap rate was down 8bps, reversing the previous day’s move higher, while the 5-year rate was down 11bps, back to 4.16%.  The sharp fall in NZ rates on Friday was all the more impressive because it occurred against a backdrop of flat-to-higher global rates.  

Up ahead tonight, Liz Truss, who has campaigned on cutting taxes (probably not what the Bank of England would like to see at this point), is expected to be confirmed as the new UK prime minister.  The recent simultaneous sell-off in the GBP, which ended last week just above 1.15, and UK gilts, suggest investors are worried that Truss’s populist policy mix could exacerbate the stagflationary backdrop.

As for the rest of the week, it’s shaping up to be another busy one.  The ECB meeting on Thursday night is the main event, with markets now favouring a 75bps hike by the central bank, which would take the deposit rate up to 0.75%.  In Australia, the RBA is expected to hike its cash rate by another 50bps tomorrow (>90% priced in) while the Bank of Canada is expected to hike its cash rate by 75bps, to 3.25% later in the week.  Fed speakers are out in force again, including Chair Powell on Thursday night and Vice Chair Brainard the night before.  The ISM Services index is the main data release in the US.  The market is looking for a slight fall in the index, to a still healthy 55.4, although the shockingly weak Markit Services PMI for August (44.1) probably warns of downside risk to that consensus estimate.  Domestically, there is just second-tier data released including a number of GDP partial indicators which will help us firm our forecast for Q2 GDP growth (currently 1.5% q/q pencilled in).