Today’s June non-farm payroll data was much stronger than expectations: 287,000 jobs were added against expectations of 180,000 jobs added. The disappointing May figure was revised down to 11,000 jobs from 38,000 jobs added and the two monthly revision came in at -6,000. The unemployment rate edged up to 4.9 percent and the participation rate also edged higher to 62.7 percent. The average hourly earnings came in at 2.6 percent yoy, slightly below expectations, and up from 2.5 percent yoy the prior month. Average hours worked was unchanged at 34.4.
The stronger than expected figure adds some credence to San Francisco Fed President John Williams’ comments earlier this week that the May job weakness was overstated due to the Verizon strike and weather effects: good weather earlier in the year meant more jobs were added earlier in the year which was reflected in the strong February print. Adjusting for these he argued “you basically see a pattern that job growth has continued to be very good, above trend, through the six months of this year.”
Nevertheless, the Fed is likely to remain patient as the minutes from the June FOMC was peppered with the word “uncertainty” and stated “it was prudent to wait for additional data regarding labor market conditions as well as information that would allow them to assess the consequences of the U.K. vote for global financial conditions and the U.S. economic outlook.” William Dudley, the New York Fed President, also commented this week: ‘With uncertainties about the outlook and inflation being lower than desired, it allows us to be a little more patient. If you strip out the energy sector, inflation is still a little below what we would like… so that allows us to be patient in terms of letting the economy run with accommodative monetary policy in place. If inflation were higher … we could probably be a little more aggressive in terms of monetary policy.’
Obviously, the Brexit vote has increased uncertainty; it is negative for growth along with the tightening effect of the US dollar’s strength. Even with today’s strong payroll figures the Fed is likely to remain patient until it has a better gauge on how events, which happened after the figures were compiled, are impacting growth. We still see a lot of downside risks to US growth and expect the ‘dot plot trajectory’ to remain shallow and if there is any further tightening for it to be extremely gradual, providing inflation remains benign. Policy ultimately remains data dependent. At the time of writing, the Fed Futures are still only implying a 23.7 percent chance of a rate rise in December 2016 against expectations of 11.8 percent ahead of the data release.
Over the past few weeks, the US Treasury yield curve has been flattening; this trend is supported by the negative impact of the Brexit vote on global growth expectations, less confidence in US growth and the Fed’s ability to raise rates, uncertainty driving a ‘flight to safety’ and US dollar strength. Even if US data supports another rate rise we expect the Fed will remain ‘ahead of the curve’ and the yield curve will flatten favouring positioning at the long end on a duration weighted basis.
In a world where close to USD 11.7tn of sovereign yields trading on negative rates high quality Eurobonds offering positive yields, particularly from creditor nations, continue to look compelling investments.