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US payrolls in focus, as yields struggle

the jobs page in a newspaper

Despite the bad news that the market had to digest yesterday, it was surprising that European markets managed to finish the day in the green as investors absorbed the biggest rate hike by the Bank of England in 27 years.

US markets finished the session mixed, with the Nasdaq 100 closing higher with the Dow and S&P500 closing lower, while yields fell too.

The fall in yields suggests that bond markets are ignoring central bank tightening, and focussing more on a looming slowdown and recession.   

The June payrolls reports posed more questions than answers when it was released a month ago, even though it was the weakest number this year at 372k.

It was still much higher than expected with the unemployment rate steady at 3.6%. Wages growth remained steady at 5.1%, while the May numbers were revised up to 5.3%, however the fall in the participation rate to 62.2% was puzzling.

With wages rising at a slower rate than inflation, and vacancies at record levels this ought to be going the other way but isn’t.

With the US labour market still looking solid we are now starting to see some evidence of weakness in the services sector, while weekly jobless claims have been rising steadily for three months now, and are back above 250k, having hit a 50 year low of 167k back in April.

The rise in jobless claims appears to be the first sign the US labour market is showing signs of weakness even if this isn’t being reflected in the actual numbers.

After the ambiguity of the Powell press conference post the Fed raising rates by 75bps, we’ve had a succession of FOMC members push back on the narrative that was taken from that meeting that the Fed could be about to pivot. The most hawkish of those policymakers, St. Louis Fed President James Bullard was insistent that the Fed funds rate was on course to be at 4% by year end. This, along with comments from Loretta Mester of the Cleveland Fed helped to push US yields sharply higher, however the rise turned out to be fairly short lived.

This week’s US economic data appears to show that inflation pressures are easing, while hiring is still holding steady, which has also weakened the US dollar.

Today’s July payrolls are expected to see 250k jobs added, which coincidentally was the forecast for June, which was beaten quite comfortably. It will still be the lowest number this year, however the strength of the labour market may well be starting to increase in the level of importance when it comes to how aggressive the Fed is likely to be when it comes to tackling inflation.   

Wages are expected to remain steady at or around 5%, and the unemployment and participation rate to remain steady at 3.6% and 62.2%.

Given the shift in emphasis in this week’s comments from Fed policymakers the better the number will likely determine how aggressive the Fed is likely to be when it comes to tackling inflation with the phrase “front-loading” being used quite a lot. A weak jobs number could temper the Fed’s hawkishness, but it would have to be a shockingly low number, or even negative.

We also saw a slide in bond yields in the aftermath of yesterday’s historic decision by the Bank of England Monetary Policy Committee to raise interest rates by 50bps for the first time since the central bank got its independence in 1997.

While the decision to raise rates wasn’t a surprise, the economic summary that came afterwards was, and it was bleak.

Central banks generally tend to soft soap when it comes to bad news, however the frankness behind the Bank of England’s economic assessment was as dark as it could be. Reading back through it a second time, and having had time to absorb the contents, it still doesn’t read any better.

There was nothing good in it when it came to the short-term economic outlook, with the pound sliding back against the US dollar and the euro, and while it pared its losses against a weakening US dollar it still lost ground against the euro. This was somewhat surprising given that even with the problems facing the UK, the impact on Europe of current events is likely to be even worse.

The Bank of England said it expects inflation to peak at 13.3% in October, up from its June forecasts of 11%, and to average 13.1% during Q4, while going on to say that it expects inflation to remain high through the whole of 2023.

This means all things being equal we can expect to see the potential for another 50bps rate hike next month, and probably more rate hikes before year end, given that the US Federal Reserve has already indicated it will move by at least a similar amount at its September meeting.

For Q3 2023, a year from now, the Bank of England is forecasting that CPI will only fall to 9.5%, only marginally above the level it is now, with prices set to fall quite sharply thereafter, in 2024.

The bank said it also expects core prices to pick up, although not by as much, expecting them to peak at 6.5%, by the end of this year, which means that food and energy will make up over half of headline CPI over the next 6 months.

The bank also downgraded its GDP forecasts for this year, next year and into 2024, in essence laying out the expectation that we will see a long and painful recession throughout 2023, and the worst slowdown since 2008.

The projections show the UK economy contracting by 1.25% in 2023, and 0.25% in 2024, with unemployment set to rise to 6.3% in 2025.

With an outlook that bleak, who would want to jump into the job of UK Prime Minister, now or at any time over the next 12 months, as the UK heads into an economic storm?

There is little doubt that the new Prime Minister will need to take additional fiscal measures in the form of an emergency budget to support an economy that is already on the cusp of a recession, and where annual energy bills look set to rise to £3,850 next year.

There are a couple of silver linings, firstly the unemployment rate is still low, and vacancy rates are still high. There is also the fact that the Bank of England’s assessment is too bleak an outlook and takes no account of the prospect of new fiscal measures in the autumn by a new PM and Chancellor of the Exchequer, which could soften the impact of what’s coming.

None of that will do much to soften the impact of a sharp drop in real incomes over the next two years.

Quite frankly with an outlook this bleak, doing nothing is not an option for any government with an election due in 2024.

EUR/USD – still having trouble breaking above the 1.0280 area. While below the bigger resistance at 1.0350, the risk remains for a move back towards parity, and the previous lows at 0.9950. A move below 0.9950, towards 0.9660. 

GBP/USD – saw a sharp fall to 1.2060 before rebounding back above 1.2200, as we look to determine the next move. The 1.1980 area remains a key support level, which while above keeps the prospect of a move back to 1.2300 on the cards.

EUR/GBP – having held above the 0.8340 area for three days in a row we’ve squeezed higher with resistance at the 0.8480 area. While below the 0.8480 area, momentum remains negative for a move towards the 0.8300 area.  

USD/JPY – after this week’s dip to the 130.40 area we’re running into resistance at the 134.80 area and 50-day SMA. The bias remains lower while below the 50-day SMA. A move above 134.80 retargets the 136.30 area.


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