Wealthy Nations Daily Update - Non Farm Payroll

On Wednesday Janet Yellen noted in her testimony before the House Financial Services Committee “at this point, I see the US economy as performing well” and that a rate increase in December remained a “live possibility” but remained data dependent. Inflation, despite running “considerably” below the FOMC’s 2% objective, is viewed as reflecting “declines in energy prices and the prices of non-energy imports” and “If we were to move, say in December, it would be based on an expectation, which I believe is justified, that -- with an improving labor market and transitory factors fading -- that inflation will move up to 2 percent.”

Following the release of the FOMC minutes and Janet Yellen’s latest comments market expectations have moved significantly to reflect the increased likelihood of a rate rise: ahead of today’s non-farm payroll data market expectations for a rate rise in December was 56 percent.

Today’s non-farm payroll data is supportive of a December rate rise; at the time of writing expectations for a December rate rise have risen further to 70 percent. The Treasury yield curve has flattened.

The October non-farm payroll data showed that 271,000 jobs were created in October which was significantly ahead of the Bloomberg consensus expectation of 185,000 jobs added. The two-month payroll net revision was +12,000. The unemployment rate edged down to 5.0% from 5.1% in September. The participation rate was unchanged from the prior month’s reading of 62.4%.

Added to this, there was an increase in average hourly earnings which rose 2.5% yoy versus expectations of a 2.3% yoy rise and the prior month’s revised reading of 2.3% yoy. Average weekly hours worked came in unchanged at 34.5 versus expectations of 34.5.

The key take-away is that zero interest rates are not normal and the Fed is looking to begin the process of interest rate normalisation, but policy is still likely to remain accommodative and the trajectory and pace of further interest rate rises slow. Provided a central bank is ahead of the curve, yield curves typically flatten as inflationary expectations decline. In the last three tightening cycles the short end of the bond market has delivered losses to investors, however, the long end has tended to perform much better. We expect any move by the Fed to start to raise rates will be well ‘ahead of the curve’ and the yield curve should remain quite flat, favouring positioning at the long end on a duration weighted basis.