Today’s U.S. unemployment report could affect Fed’s timing
German 10-year Bund yield surges above 0.50% and T-note yield partially follows
Today’s U.S. unemployment report could affect Fed’s timing — Today’s June unemployment report could affect the Fed’s timing for the start of its balance sheet reduction program and/or its next rate hike. An unemployment report today showing weak payroll and wage growth could cause the Fed to defer its next tightening move until later in the year. By contrast, a report today with strong payroll and wage data would encourage the Fed to move ahead with its apparent plan for either a rate hike or a balance sheet announcement by its September meeting.
The June 13-14 FOMC meeting minutes released earlier this week showed a split where some FOMC members wanted to move ahead with a balance sheet announcement within a “couple of months” whereas others wanted to wait until later in the year to leave more time to assess the economic and inflation data. Strong payroll and wage data today would give the hawks the upper hand with a possible announcement by the Sep 19-20 meeting for a balance sheet draw-down starting on Oct 1. By contrast, weak data today would give the doves the upper hand on deferring a balance sheet announcement until later in the year.
Some FOMC members have been getting cold feet about the Fed’s fairly aggressive tightening schedule due to the recent spate of soft U.S. economic data, which includes the disappointing 3-month string of payroll reports (March +50,000, April +174,000, May +138,000). The Bloomberg U.S. Economic Surprise index has fallen sharply in the past several months into negative territory, illustrating how the recent economic data has under-performed market expectations. The recent soft U.S. economic data caused the AtlantaFed’s GDPNow to cut its Q2 GDP estimate to +2.7% from its +4.0% estimate seen just five weeks ago.
The market consensus for today’s June payroll report is for an increase of +177,000, which would be close to the 12-month trend average of +189,000 and well above the poor 3-month moving average of +121,000. However, yesterday’s June ADP report did not bode particularly well for today’s payroll report. The June ADP report of only +158,000 was weaker than market expectations of +188,000 and there were downward revisions totaling -48,000 for April-May. A weaker-than-expected payroll report today would cause more concern about the U.S. economy and would encourage market ideas that the Fed will not be able to tighten as quickly as it wishes.
The markets will be watching today’s wage data very carefully since the Fed believes that the current tightness in the labor market should in theory be pushing wages higher, thus putting upward pressure on inflation. The market consensus is for today’s June average hourly earnings report to edge higher to +2.6% y/y from May’s +2.5%, which would still leave the series well below the 8-year high of +2.9% posted in Dec 2016. A weak wage report today would contribute to low-inflation worries among the more dovish FOMC members. By contrast, a strong wage report would strengthen the hawks’ argument that the current softness in inflation is transitory and that the Fed’s tightening process should proceed without delay.
Regarding the unemployment rate, the consensus is for today’s June unemployment rate to remain unchanged from May’s 16-year low of 4.3%. Any further drop in the unemployment rate would fuel more worries at the Fed about running the labor market too hot and causing wage and price inflation down the road. The current 4.3% unemployment rate has already essentially met the Fed’s forecast of 4.2-4.3% for 2017-2019 and is below the Fed’s estimate of a longer-run natural unemployment rate of 4.6%.
German 10-year Bund yield surges above 0.50% and T-note yield partially follows — The German 10-year bund yield on Thursday surged to a new 1-1/2 year high of 0.574% and closed the day sharply higher by +9.2 bp at 0.562%. Thursday’s sharp rise in the bund yield was sparked by poor investor demand for the 30-year French government bond auction. The German 10-year bund yield has now surged by 31.7 bp just since last Tuesday when ECB President Draghi appeared to start the ball rolling on preparing the markets for QE tapering. Mr. Draghi said that reflation had replaced deflation and that the ECB could tighten up the parameters of its monetary policy while still leaving policy essentially unchanged because of the improving economy.
The current surge in German bund yields is being called “Der Taper Tantrum” by some due to similar circumstances in 2013 when the 10-year T-note yield surged by about +60 bp over the space of just 6 weeks after then-Fed Chair Bernanke hinted that the Fed might taper QE3 later in the year. Mr. Bernanke later said that he did not think it was the tapering threat per se that caused the surge in yields, but rather the market’s view that the next rate hike would come sooner than earlier thought with QE3 tapering issue out of the way. The markets current expect the ECB in September or October to announce a QE tapering during the first half of 2018.
The surge in the 10-year Bund yield has clearly pushed the 10-year T-note yield sharply higher. The 10-year T-note yield on Thursday rose to a new 1-3/4 month high and closed the day up +4.3 bp at 2.366%. The 10-year yield since last Monday has moved sharply higher by +23.1 bp, which isn’t far behind the 31.7 bp surge in the bund yield over that same time frame. The 10-year T-note has also been pushed higher by (1) the +5.2 bp rise in the 10-year breakeven rate seen since last Monday, which illustrates higher inflation expectations, and (2) the +14 bp rise in the Dec 2018 fed funds futures contract that illustrates tighter Fed expectations over the next 1-1/2 years.