- Weekly market focus
- Payroll report averts disaster but payroll growth is still downshifting
- Dovish Fed policy expectations are little changed despite strong payroll report
- 3-year T-note auction to yield near 0.71%
- Q2 earnings expected to show a fourth quarter of negative growth
Weekly market focus — The markets this week will focus on (1) the continued assessment of Fed policy after last Friday’s surprisingly-strong U.S. payroll report of +287,000, (2) whether the Bank of England at its policy meeting on Thursday cuts interest rates in response to the recent Brexit vote, (3) Thursday’s Chinese Q2 GDP report, which is expected to ease slightly to +6.6% y/y from +6.7% in Q1, (4) the beginning of Q2 earnings season today with Alcoa’s report with expectations for a -4.8% y/y decline in Q2 SPX earnings growth, and (5) the Treasury’s sale this week of $56 billion of 3-year, 10-year, and 30-year securities.
This is a busy week for Fedspeak with eight appearances by various Fed officials. The markets will be listening carefully to see if FOMC members are turning somewhat more hawkish given last Friday’s strong payroll report and the fact that the U.S. stock market has already shaken off the Brexit vote.
Key reports on this week’s U.S. economic calendar include (1) Tuesday’s May JOLTS report, (2) Wednesday’s Fed Beige Book, (3) Thursday’s June PPI report (expected -0.1% y/y and +1.0% y/y core), (4) Friday’s June retail sales report (expected +0.1% and +0.4% ex-autos), (5) Friday’s July CPI report (expected +1.0% y/y and +2.3% y/y core, little changed from June’s +1.0% and +2.2% core), (6) Friday’s June industrial production report (expected +0.2% after May’s -0.4%), and (7) Friday’s preliminary-July University of Michigan U.S. consumer sentiment index (expected -0.5 to 93.0).
Payroll report averts disaster but payroll growth is still downshifting — Last Friday’s June payroll report of +287,000 was far above market expectations of +180,000 and relieved fears of a major slowdown in U.S. hiring. The report suggested that the very weak May report of +11,000 (revised) was caused mainly by the failure of the seasonal adjustment factors to accurately account for school closings this year. The Verizon strike also shook up the data, except that the market was aware of those figures. The strong June report produced a May-June average increase of +149,000, which was still not particularly strong but was a big improvement over the initial May report of +38,000.
The 3-month average payroll increase is now only +147,000, which is far below the average monthly payroll growth of +229,000 seen in 2015. It is not surprising that payroll growth is slowing since (1) the U.S. economy is now near full employment, (2) businesses need to cut expenses in the midst of a year-long profit recession, and (3) businesses have reduced incentives to engage in new hiring with weak U.S. and overseas growth and with poor labor productivity and rising wages.
Dovish Fed policy expectations are little changed despite strong payroll report — The federal funds futures curve surprisingly moved higher by only 1-3 bp in response to last Friday’s strong payroll report. That small move suggests that the market was not overly impressed with the payroll report. Indeed, the market is still focused on Brexit as a major risk for the global economy as well as expectations for a lackluster U.S. economy over at least the next few quarters.
The federal funds futures market is discounting a zero chance for a rate hike at the next FOMC meeting on July 26-27 and a 10% chance for a rate hike at the following meeting on Sep 20-21. The market is discounting only a 22% chance of a rate hike by year-end, down sharply from 62% prior to the Brexit vote. The market is not fully discounting the next rate hike until November 2018, which is 2-1/3 years away.
3-year T-note auction to yield near 0.71% — The Treasury today will sell $24 billion of 3-year T-notes. The Treasury will then continue this week’s $56 billion coupon package by selling $20 billion of 10-year T-notes on Tuesday and $12 billion of 30-year T-bonds on Wednesday. The 10-year and 30-year auctions will be the second reopenings of the securities that the Treasury first sold in May.
Today’s 3-year T-note issue was trading at 0.71% in when-issued trading late last Friday afternoon, which translates to an inflation-adjusted yield of -0.64% against the 3-year breakeven inflation expectations rate of 1.35%. The 12-auction averages for the 3-year are as follows: 2.97 bid cover ratio, $54 million in non-competitive bids, 4.0 bp tail to the median yield, 21.0 bp tail to the low yield, and 42% taken at the high yield. The 3-year is the second least popular security among foreign investors and central banks behind the 2-year. Indirect bidders, a proxy for foreign buying, have taken an average of only 50.3% of the last twelve 3-year T-note auctions, well below the average of 57.4% for all recent Treasury coupon auctions.
Q2 earnings expected to show a fourth quarter of negative growth — Q2 earnings season begins this week with 14 of the S&P 500 companies scheduled to report. Notable reports include Alcoa today; Yum! Brands on Wednesday; JPMorgan Chase and BlackRock on Thursday; and Citigroup, US Bancorp and Wells Fargo on Friday.
The market consensus is for Q2 earnings growth to fall -4.8% y/y, according to surveys by Thomson Reuters. That would be the fourth consecutive month of negative earnings growth. However, the consensus is for earnings growth to return to positive territory in Q3 with a +1.7% y/y increase and then improve to +9.3% in Q4 and +15.7% in Q1. On a calendar year basis, earnings growth in 2016 is expected to be unchanged from 2015 at a negligible +0.2%, but the market is then expecting a substantial improvement to +14.4% in 2017.
