Thursday 19 September 2019

Daily Market Update: Dollar rises further as sharp improvement in US payrolls paves the way for December Fed hike


Simon Barry

Friday’s US employment report was without doubt considerably stronger than expected.

After disappointing back‐to‐back outcomes in August and September, payroll gains reaccelerated strongly last month, with total non‐farm payrolls rising by 271k – way ahead of Wal Street expectations for a rise of 180k and the strongest month for jobs since December last year. Improvement was broadly‐based, wit manufacturing, construction and private services all registering better performances in October. In particular, private sector services employment (which accounts for over 70% of all employment in the US) picked up smartly last month, chalking up monthly gains of 241k, up from around 150k per month on average in August / September. Beyond payrolls, the unemployment rate fell from 5.1% in September to a new cycle low of 5% ‐ a level of unemployment that corresponds to full employment according to the latest estimates from the Fed. Moreover, the tightening of the labour market is now becoming more visible in earnings trends: annual growth in average hourly earnings broke out of the narrow 1.7‐2.3% range that has prevailed for most of the post‐crisis period in accelerating to 2.5% ‐ its strongest reading in over 6 years.

More broadly, Friday’s figures provide important evidence that after a late‐Summer soft spot, the US jobs market recovery – and by extension that of the wider US economy – is again showing renewed vigour as the economy moves through the early part of the final quarter. Crucially, this development makes it highly likely that the Fed will indeed proceed with its signalled rate increase in December While there are other important data points between now and when the Fed meeting takes place on December 16th, notably including the November jobs report (due on December 4th), our take is that barring significant weakness in incoming economic news, the Fed wi go ahead and raise rates as it had indicated was likely in its October statement two weeks ago. Having been somewhat taken aback by the hawkish signal from the October statement, markets are continuing to adjust to the reality that US rates are in fact headed higher.

Bond and interest rate markets are particularly in adjustment mode, in line with the risk we have been flagging for some time given the large gap between interest rate market pricing and Fed guidance. Notably, 2‐year bond yields have jumped by a further 7bps since Friday’s figures, bringing the cumulative increase since the October FOMC statement to over 25bps and in the process taking yields to 0.9% ‐ their highest level in about five and a half years. In turn, the firming of Fed rate expectations is providing the to‐be‐expected boost to the dollar on the exchanges. Relative to where it was early on Friday, the greenback is 0.8 and 1% higher against the pound and euro at $1.5070 and $1.0765 respectively as the buck continues to build on prior gains. We continue to see the need for a further adjustment in US rate expectations implying the likelihood of further downside for Eur/USD in particular from here, with our forecast o $1.06 looking like its going to be reached much earlier than previously expected. The low during this year so far was around $1.0460 (reached in March) – a level that looks set to be tested in the coming weeks as markets count down both to what is shaping up to be a very interesting run in to year‐end which in December could feature the first US rate hike in nine years and a possible further bout of stimulus from the ECB.

Looking to the week ahead, the preliminary estimate for Eurozone GDP growth in Q3 is announced on Friday. GDP advanced 1.5% in Q2 and expectations are for 1.7% y/y in Q3. Analysts will pay even closer attention than usual as markets try to gauge how global market volatility in late August and September impacted economic activity in the Eurozone, particularly in light of ECB President Draghi maintaining last week that an expansion of the existing quantitative easing program will be thoroughly considered during their December meeting. More timely data (most notably the composite PMI) indicates that the economy continued to grow at modest‐to‐ moderate levels which most likely won’t push the needle on QE talks one way or another.

In the UK, earnings data and the unemployment rate for September are released on Wednesday. The 3 month average unemployment rate is expected to remain at 5.4% while expectations are for 3 month average weekly earnings (ex‐bonuses) growth to publish at a healthy 2.7% y/y clip after 2.8% in August. A key component of last week’s Bank of England Inflation Report was an emphasis on the resilience in the strength of prospects for domestic demand linked to a positive outlook for earnings growth, putting even more focus on the already critical labour market.

In the US, retail sales both headline and core (ex. auto & gas) are reported for October and are expected to accelerate from 0.1% and 0.0% to 0.3% m/m and 0.4% m/m respectively. The provisional November estimates for the University of Michigan consumer survey ar published on Friday and the consumer sentiment index is expected to pick up from 90 in October to 91.3. Medium term inflation expectations are also announced after printing at 2.5% in October.

ECB president Mario Draghi and Bank of England Governor Mark Carney speak at a Bank of England event on Wednesday. Carney may wish to address the dovish message markets took away – more than was intended, in our view – from last week’s Inflation Report. Finally, Fed Chair Yellen gives the opening remarks of a conference on monetary policy hosted by the Fed on Thursday and her comments will be closely scrutinised as markets attempt to gauge her view on the near‐term monetary policy outlook in the wake of last week’s impressive payrolls release

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