Today’s July non-farm payroll data was stronger than expectations: 255,000 jobs were added against expectations of 180,000 jobs added. The strong June figure was revised up from 287,000 to 292,000 jobs and the two month revision came in at 18,000. The unemployment rate was unchanged from the previous month at 4.9 percent and the participation rate edged up to 62.8 percent. The average hourly earnings came in at 2.6 percent yoy, in line with expectations and the prior month. Average hours worked edged higher to 34.5.
Ahead of the release the futures were only looking for an 18 percent chance of a hike in September this year and a 37 percent probability of a hike by the end of the year. Expectations have reset somewhat on the back of today’s strong data with the market now pricing in 24 percent chance of a hike in September at the time of writing and the 2017 probability for a March hike has increased to 50.6 percent.
The reluctance of the futures to price in a greater likelihood of a hike this year likely reflects the mixed nature of the data releases and increased uncertainty about the global economy. For example, Q2 GDP was weaker than expected only registering 1.2 percent annualised growth (against expectations of 2.5 percent) and Q1 growth was revised down to 0.8 percent leaving growth in the first half at 1 percent annualised. Consumption was robust (+4.2 percent) but business investment (-2.3 percent), residential investment (-6.1 percent) and an inventory adjustment (-1.2 percent) were notable drags on growth. To hit the FOMC’s 2 percent target growth will now requires 3 percent growth in the second half. Added to this the inflation outlook remains benign: the June PCE deflator increased 0.9 percent yoy and the core reading was at 1.6 percent yoy.
Earlier in the week commentary from William Dudley, the New York Fed President, noted that “even 150,000 job gains per month would be consistent with gradually using up any remaining slack present in the U.S. labor market.” However, he also noted that “the medium-term risks to the U.S. economic growth outlook are somewhat skewed to the down side” and “U.S. financial market conditions depend, in part, on the stance of U.S. monetary policy relative to monetary policies abroad. If the economic outlook abroad deteriorates and this causes foreign countries to pursue a more accommodative set of monetary policies, then the dollar would likely appreciate…. In this case, the U.S. may need to adjust its own monetary policy path.” He goes on to note: “given how close we remain to the zero lower bound for interest rates, I also think the risks are asymmetric. Therefore, we need to be a bit more careful about the risk of tightening monetary policy in a manner that proves to be premature, as compared to the alternative risk of being a little late.”
Despite today’s strong employment data we expect the Fed to remain ‘patient’ and take a very gradual approach to tightening rates. We expect they will remain ‘ahead of the curve’ and the yield curve will continue to flatten favouring positioning at the long end on a duration weighted basis. This week the BoE was the latest of the central banks to cut rates and step up QE on concerns about the negative impact of Brexit on growth. Unconventional monetary policy is bringing a great deal of uncertainty to global markets and increasing the search for yield as more and more bonds trade at lower or negative yields: high quality bonds from creditors, particularly those offering positive yields, remain one of the more attractive places to be positioned.