The Weekly Update

Fridays February non-farm payroll release showed 235,000 jobs added which was above expectations of 200,000 jobs created and the prior month’s reading was revised up by 11,000 jobs to 238,000.  The construction sector, helped by the mild winter weather, saw strong job gains of 58,000, the largest gain since March 2007; while the manufacturing sector saw robust gains at 28,000 jobs, the most since August 2013.  The unemployment rate edged lower to 4.7% from January’s reading of 4.8% although the participation rate edged higher to 63 percent as more people entering the workforce found jobs.  Average hourly earnings grew 2.8% yoy which was in line with expectations and the upwardly revised January figure of 2.8% yoy (from 2.5% yoy).

The market is now fully discounting a 25 basis point hike in the Fed Funds rate in March and further rate rises thereafter. US Treasuries closed with little change on the back of the figures.  The key point is that the inflation backdrop remains benign and the Fed is moving ahead of the curve.  Thus, our view remains that the yield curve will flatten and we favour positioning at the long end of the yield curve.  If the US economic data points remain strong then it is likely that there could be an additional two 25 basis point hikes as the year progresses.  Our proprietary models suggest that the 10-year US Treasury yield above 2.5% is already discounting this.

In terms of positioning, we look to target the long end on a duration weighted basis and have been looking to manage our position by selling outperformers in the belly of the curve.  Although Europe has creditor nations the lack of value on our models makes this an easy risk to avoid.  While spreads in investment grade credit may not tighten significantly from current levels we still see opportunities from targeting undervalued credits with several notches of credit cushioning versus their rating and which trade on attractive positive yields.

In other news last weekend the Chinese Premier Li Keqiang acknowledged the government’s efforts to steer the world’s second largest economy to a ‘new normal’ of slower but better quality growth, that is more geared towards domestic consumption and less debt dependant. Such a transition is not an easy one; as Mr Li put it ‘Like the struggle from chrysalis to butterfly, this process of transformation and upgrading is filled with promise but also accompanied by great pain’.

Mr Li was speaking at the start of the National People’s Congress where he also said that the annual economic growth target for 2017 would be around 6.5%. Last year at the same conference the target for growth was put at between 6.5 and 7%; actual growth came in at 6.7%. The Chinese government are willing to sacrifice a small percentage of growth in exchange for paying more attention to financial and economic risks in the coming months and years. ‘Financial supervisors should fix weak links and act hard against illegal activities’ he said whilst believing that there is a need to rein in house prices, as houses are to be lived in, not for speculation, referring to the recent big increases.

Closer to home and as expected, Philip Hammond’s first and last Summer Budget delivered numerous but all modest adjustments to overall government spending. This has been reflected in markets with both sterling and Gilts little changed from before his speech. Beyond the peppered insults towards the leader of the opposition, the most notable mentions were the changes to the OBR’s forecasts.

An estimated £24bn less public sector net borrowing over the current and next 5 years, from more resilient growth and tax receipts, will support the Chancellor’s vision for ‘Getting Briton back to living within its means’. The overall growth forecast over the next 5 years remains little changed, but the trajectory places more of that growth in the current year (2%, up from 1.4% previously) whilst reducing subsequent years’ growth by 0.1%, 0.4% and 0.2% for 2018, 2019 and 2020 respectively.

Attempts to equate the taxation between the employed and self-employed was probably the most significant revenue bolstering announcement, alongside commitments to ‘tackle avoidance, evasion and noncompliance’. Other notable initiatives include the introduction of T-Levels, new technical qualifications; funding for 110 new free schools; counterbalancing measures for the forthcoming increase in small business rates and an overall drive to boost productivity. However, with the vast number of restrictions and protected spending across almost every department, and the Conservative’s election manifesto promising no income, value added or NIC tax increases, these bean-counting adjustments are about as much as could be expected from a Chancellor with his hands tied.

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