Strong US Jobs Data And Hawkish Fed Speak Keeps Tightening Expectations Elevated

US bond yields rose sharply on Friday, particularly on the front end of the curve in the wake of the above consensus US July jobs report, which showed a strong 528,000 (consensus 250,000) increase in non-farm payrolls and the unemployment rate dropping to 3.5% (consensus 3.6%).  The three-month moving average of US jobs gains now total 437,000. However, the drop in the unemployment rate was due in part to a drop in the participation rate so it wasn’t all good news.  Wage growth was firm, with average hourly earnings up 5.2% y/y. Overall the data highlighted a still strong jobs market and markets are now pricing in a greater probability of 75 basis points hike by the Federal Reserve at its September meeting. 

The firm US jobs data accompanied hawkish Fed speak over the past week, with various Fed officials pushing back against more dovish rate expectations that had been built into markets over recent weeks. The Fed’s Evans, Kashkari and Daly are scheduled to speak this week and are likely to maintain the run of hawkish Fed comments, pushing back against residual expectation of an early peak in the Fed Funds rate. Despite weaker closes for equities on Friday, stocks still ended higher over the week, but may struggle given the renewed hawkish shift in rate expectations.  That said, with the bulk of second quarter earnings out of the way equities have held up well. 

The data and Fed speakers also give further reason to be cautious on extrapolating the recent pull back in the US dollar, with the currency bouncing at the end of the week and starting this week on a firm note.  The USD index has bounced off trend line support and has bounced off its 50-day moving average level, which has been a good support over recent months.  In the near term some consolidation in the USD is likely though this week’s US CPI inflation report is likely to provide more direction.  Conversely, while the euro appears to have found a short-term bottom, it’s hard to see a significant bounce in the currency. 

Data over the weekend revealed a stronger than expected increase in Chinese exports in July at 18% y/y (cons. 14.1%) and lower imports at 2.3% y/y (cons. 4.0%), resulting in a surge in the trade surplus to $101.26bn (cons. $89.04bn).  The weak imports data highlights ongoing pressure on domestic demand while exports will likely struggle to maintain firm momentum amid a likely slowing in external demand.  China’s July inflation data this will be in focus (Wed) this week while more reaction by China to last week’s visit by Speaker to Pelosi to Taiwan will also be expected. 

In the US, the key data will be the July CPI report (Wed); the consensus expects elevated readings of 8.7%/6.1% y/y for total/core prices.  Headline CPI will have moderated from June, but core CPI is likely to have ticked higher.  Long term inflation expectations as measured in the University of Michigan August confidence survey (Fri) will also be in focus.  On the policy rate front, a 25bp hike from the Bank of Thailand kicks of its tightening cycle (Wed) and a 75bp hike from Mexico’s central bank, Banxico.  However, unlike Thailand Banxico is likely nearing the end of its tightening cycle.   

Will The Fed Hike By 50bp? Asia Singing To Its Own Tune

The outsized gain in the US January CPI inflation rate has firmly put a 50 basis points (bp) Federal Reserve rate hike on the table as well as reinforcing expectations of a series of consecutive rate hikes while St Louis Fed President Bullard even raised the prospect of an inter-meeting hike in the wake of the CPI data.  Markets are now pricing close to 7 hikes in 2022 and 80% odds of a 50bp hike in March. 

US CPI inflation jumped to 7.5% y/y, a 40-year high, with prices rising by 0.6% m/m and core CPI rising to 6% y/y, all above consensus.  In the wake of the data Bullard strengthened his hawkish rhetoric by saying that he would like to see 100bp of hikes by July 1 2022.  Markets have quickly ramped up their expectations for Fed tightening, with a growing chorus expecting a series of consecutive hikes.

Markets are reacting badly, with equities under renewed pressure, bond yields moving higher and the US dollar firming.  It’s hard to see such pressure easing anytime soon.  Historically the bulk of market pressure takes place as the market prices in / discounts rate hikes rather than after the Fed actually hikes.  This suggests that markets will remain highly nervous at least until the March Federal Reserve FOMC meeting. 

It is clear that the data is killing off any chance of a more tepid pace of US monetary tightening. The Fed alongside other major central banks are frantically trying to regain credibility in the wake of much stronger inflation readings than they had anticipated by espousing increasingly hawkish rhetoric, which will likely soon be followed with action as policy rates increase and central bank balance sheets start to shrink. 

There is now a growing probability that the Fed will kick off its monetary tightening with a 50bp rate hike followed by consecutive hikes in the months ahead as well as quantitative tightening in the second quarter.  It’s not quite a done deal but another strong US inflation print for February will seal the case for a 50bp hike in March.

In contrast, Asia monetary policy is singing to its own tune.  Unlike in past tightening cycles when Asian central banks were forced to tighten to avoid pressure on their markets, especially to avoid currency weakness, there is limited signs of such pressures at present.  Some in Asia such as the Bank of Korea and Monetary Authority of Singapore have tightened already, but this is largely due to domestic factors rather than the Fed.

The stark difference in stance between Asian central banks and what is being priced in for the Fed has been particularly apparent by the recent dovish policy decisions in India, Indonesia, and Thailand, with all three central banks showing no urgency to tighten.  Similarly, the Bank of Japan acting to defend its yield curve policy by conducting unlimited fixed-rate JGB purchases, was clearly a dovish move.  Last but not least, the PBoC, China’s central bank has already cut its policy Loan Prime Rate and is likely to do so again in the next few months.  

Turkey, Emerging Market Central Banks, Eurozone Divergence

Attention today is on developments in Turkey. Despite consensus expectations of a 100bp (1%) hike in rates, Turkey’s central bank delivered a bigger than expected 200bp increase last week, with a hawkish statement.  This appears not have been welcomed by Turkish President Erdogan who promptly removed central bank (CBRT) Governor Aqbal on Saturday.  Despite some reassurance from Aqbal’s replacement that policy would deliver price stability the result has been substantial pressure on Turkey’s currency the lira (TRY) at the start of trading in Asia today, with the lira down as much as 15% initially, erasing more than four months of gains.  Turkish authorities are likely to intervene to limit the damage, but the damage has been done.  There has also been some, albeit more limited fall out on other emerging market currencies.

The end of the week saw a bit of a reversal in recent trends, with tech stocks gaining most, at the expense of bank stocks, which were weighed down by the news that the US Federal Reserve would not extend the Supplementary Leverage Ratio (SLR) exemption but rather to look at a more permanent solution. This could lower banks demand for Treasuries while constraining dealer balance sheets. Both S&P 500 and Nasdaq recorded declines over the week amid a further rise in US Treasury yields.  Quadruple witching saw an increase in volumes and oil prices recorded a sharp close to 8% decline over the week while Chinese stocks continued to suffer. 

Aside from Turkey there was some interesting central bank action last week in the emerging markets.  The BCB in Brazil hiked by 75bps, more expected, and indicated the high likelihood of another 75bps at the May meeting.  The CBR in Russia also joined in on the hawkish emerging markets (EM) action surprising markets by hiking rates by 25bps, with a likely acceleration in tightening likely over coming meetings.  EM central bank decisions this week include China (today), Philippines (Thu), Thailand (Wed), Hungary (Tue), South Africa (Thu), Mexico (Fri) and Colombia (Fri).   Separately, the SNB in Switzerland also decides on policy (Thu). China’s loan prime rates were left unchanged as expected and no changes are likely from any of the other central banks this week. 

Other data and events this week include the US PCE report (Fri), President Biden’s press conference (Thu) which could offer clues to the “Rescue” package that could amount to $3-4trn. A host of Fed speakers are also on tap, including Fed Chair Powell, as well as Eurozone flash purchasing managers indices (PMIs) (Wed), and UK retail sales (Fri).  The data will reveal stark differences in the recovery picture in the UK and Eurozone while the difference between the US and Europe looks even more stark.  Europe is struggling with a third wave of Covid case, vaccination delays and tighter restrictions, leading to a reduction in growth forecasts, while US growth forecasts are being revised higher in the wake of the $1.9tn stimulus package. This will likely result in some underperformance of Eurozone markets relative to the US.  

Chinese Data Softens

It was a tough week for risk assets last week as stocks dropped, volatility increased and the battle between retail investors and hedge funds intensified, with the latter on the losing side. The end of the week saw US and European stocks drop.  Whether the decline in stocks is due to over extended valuations, vaccine variants, vaccine supply pressures, weak activity data or more likely a combination of all of these, asset markets go into this week on a more unstable footing, with risks skewed towards pull back extending further.  It’s hard to blame day traders for the drop given that most of activity from retail traders is buying of stocks, and now silver, with heavy short position, but they are likely contributing to the rise in volatility.  The US dollar (USD) could be a key beneficiary given the massive extent of short positioning in the currency.

Data in China is showing some softening in momentum.  China’s Jan official purchasing managers index (PMI) kicked off this week’s data and event schedule yesterday, with both the manufacturing and service sector PMIs disappointing expectations; the manufacturing PMI fell to 51.3 in Jan (consensus 51.6, last month 51.9) and services to 52.4 in Jan from 55.7 previously.  China’s softer PMI once again contrasted with a series of Asia manufacturing PMIs, released this morning. Later today the US Jan ISM manufacturing index is likely to register a modest decline (consensus: 60.0 from 60.7 previously). Also in focus today is India’s budget announcement, with the Fiscal Year 2021 budget deficit likely to be around 6-7% of GDP, much higher than the original 3.5% estimate.  

Over the rest of the week there are interest rate decisions in Australia (Tuesday), Thailand, Poland (both on Wednesday), UK (Thursday) and India (Friday).  Among these the Reserve Bank of India has the most potential for a surprise relative to market expectations, with a rate cut likely.  The highlight of the week is likely to be the US January jobs report at the end of this week (consensus 55k).  Deliberations on US fiscal stimulus will also be in focus, with a group of 10 Republican Senators writing to President Biden with a $600 billion stimulus proposal, well below the $1.9 trillion put forward by the administration.  Democrats have hinted that they may push through stimulus via reconciliation, which not require Republican support in the Senate, but such a move would likely sour any mood of cooperation in the Senate. 

A Sour Note

Markets ended last week on a sour note as a few underlying themes continue to afflict investor sentiment.  The latest concern was the decision by US Treasury Secretary Mnuchin to pull back the Fed’s Main Street Lending Program despite Fed objections. The timing is clearly not ideal given the worsening in the US economy likely in the next few weeks amid a spike in Covid-19 cases, and lack of fiscal stimulus.  That said, these facilities have hardly been used, due in part to stringent terms on many of these lending facilities.  Also pulling the funds back from the Fed could give Congress room to move towards a fiscal deal.  The decision may also not get in President-elect Biden’s way; if he needs the funds for the Fed to ramp up lending the Treasury can quickly extend funding without Congressional approval when he becomes President.  However, no new credit will be available in these programs during the interim period before he takes office, which could present risks to the economy.

Equity markets will continue to struggle in the near term amid a continued surge in Covid cases.  The latest data revealed that the US registered a one-day record of 192,000 cases.  More and more states are implementing stricter social distancing measures, but its worth noting that restrictions are less severe than in March-April.   There are also growing concerns that the upcoming Thanksgiving holiday will result in an even more rapid spread of the virus, with the US centre for Disease Control and Prevention recommending Americans not travel over this period.  The battle playing on investor sentiment between rising Covid cases and the arrival of several vaccines, is being won by Covid worries at present, a factor that will likely continue to restrain investor sentiment for equities and other risk assets over the short term at a time when major US equity indices are running up against strong technical resistance levels. 

This week attention will turn to the Federal Reserve FOMC minutes (Wednesday) for the 5th November meeting.  While there were no new actions at this meeting the minutes may shed light on the Fed’s options to change “parameters” of quantitative easing (QE) and how close the Fed is to lengthening the maturity of its asset purchases.  Separately October US Personal Income and Spending data (Wednesday) will likely show some softening as fiscal stimulus fades.  Elsewhere, Eurozone and UK service purchasing managers indices (PMIs) (Monday) will likely reveal continued weakness in contraction territory as lockdown restrictions bite into activity.  Brexit discussions will be under scrutiny, with speculation growing that we could see a deal early in the week.  On the monetary policy front, decisions in Sweden and Korea (both on Thursday) will focus on unconventional policy, with potential for the Riksbank in Sweden to extend its quantitative easing program and Bank of Korea likely to focus on its lending programs and liquidity measures, rather than cut its policy rate.  Finally, expect another strong increase in Chinese industrial profits for October (Friday).

In Asia, official worries about currency appreciation are becoming increasingly vocal.  As the region continues to outperform both on the Covid control and growth recovery front, foreign inflows are increasingly being attracted to Asia.  This is coming at a time when balance of payments positions are strengthening, with the net result of considerable upward pressure on Asian currencies at a time of broad downward USD pressure.  Central banks across the region are sounding the alarm; Bank of Korea highlighted that its “monitoring” the FX market amid Korean won appreciation while Bank of Thailand announced fresh measures to encourage domestic capital outflows, thus attempting to limit Thai baht appreciation.  In India the Reserve Bank appears to be continuing its large-scale USD buying.  In Taiwan the central bank is reportedly making it easier for investors to access life insurance policies denominated in foreign currencies. Such measures are likely to ramp up, but this will slow rather than stem further gains in Asian currencies in the weeks and months ahead in my view.

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