Moderating Labor Market is what the Fed Wants

Overview:  For the large rally in US stocks yesterday and the sell-off in the dollar, US rates were surprisingly little changed. This set the tone for today's action, ahead of the US employment data. Asia Pacific equities moved higher and Europe’s Stoxx 600 has edged up to extend yesterday’s rise. The 10-year US Treasury yield is little changed, hovering around 2.91%. European benchmark yields are 1-3 bp higher. The greenback has stabilized after yesterday’s fall. The Antipodeans and Norwegian krone are weakest today, off 0.2%-0.5%. The euro and Canadian dollar are virtually flat. In the emerging market complex, Asian currencies, aside for the Philippine peso are generally outperforming central Europe. Gold initially extended its two-day (~1.7%) rally to $1874 but has reversed lower. Support is seen in the $1855-$1860 area. July WTI has been turned back from the $117.70 area. It settled near $115.10 last week and is below $116 near midday in Europe. US natgas is extending yesterday’s (~2.4%) retreat. It is off another 2% today. Iron ore rose 1.6% in Singapore. Its 8.6% gain this week is the most in three months, and likely reflects the optimism about the re-opening of Shanghai and lighter restrictions in Beijing. July copper is paring yesterday’s 5.2% surge, its biggest advance this year. It is the third weekly gain. July wheat has stabilized after falling more than 10% in the first two sessions this week. It rose 1.6% yesterday and is up fractionally today. 

Asia Pacific

Japan's preliminary May service and composite PMI were revised higher, suggesting that the world's third-largest economy continues to recovery from the Covid restrictions and mid-March earthquake. The service PMI was revised to 52.6 from 51.7. The composite PMI stands at 52.3, better than the flash estimate of 51.4. It is the third consecutive gain. It had been below the 50 boom/bust level in January and February. Separately, the BOJ offered to buy JPY50 bln of long-term bonds (25-years plus). The 3.22x the amount of selling interest was the lowest since January. Lastly, reports suggest that Japanese life insurers have boosted the proportion of dollar-denominated investments that are not hedged to the highest in more than 10 years. 

Australia's preliminary PMI was also revised higher. The service PMI was tweaked to 53.2 from 53.0, but it still is a slowing from the 56.1 reading in April. Similarly, the composite PMI stands at 52.9, which is better than the 52.5 flash estimate, but still represents a deceleration from April's 55.9 level, the best since mid-2021. The Reserve Bank of Australia is still on course to hike next week. The swaps market has a 30 bp hike priced in, while the latest Bloomberg survey finds economists a bit more hawkish. The median forecast envisions a 45 bp hike. Perhaps, the economists have been spurred by news that the Prime Minister Albanese has formally proposed lifting the minimum wage by more than the inflation. During the recent campaign Albanese called for a 5.1% increase to the current national minimum wage of A$20.33 (~$14) an hour. A decision is expected before the end of the month. 

The dollar is in narrow range against the Japanese yen. Most of the price action thus far today has been between JPY129.75 and JPY130.00. The dollar surged on the back of higher interest rates in the first part of the week but quieted down after reaching almost JPY130.25 yesterday. Ahead of the US jobs report, the greenback is up about 2.25% this week. It is snapping a three-week down draft, with its biggest gain in two months. The Australian dollar posted a big outside up day yesterday, trading on both sides on Wednesday's range and closing above its high. In fact, the Aussie closed above its 200-day moving average (~$0.7260) for the first time since late April. It edged up to almost $0.7285 today before stalling. The $0.7300 area offers psychological resistance, but the next important chart area is near $0.7345. The 4.5-cent rally off the mid-May low has stretched the momentum indicators. China's mainland, Hong Kong and Taiwan markets are closed for the holiday today. The dollar fell about 0.4% against the offshore yuan (CNH) after yesterday's 0.6% drop. This leaves the greenback near CNH6.6325, its lowest level in a month.

Europe

Oil traders were not impressed with the OPEC+ decision to boost output by around 50% to 648k barrels a day. The price of July WTI rallied 5.5% off the session low of $111.20 to $117.55, just shy of Wednesday's high. The fact of the matter is that OPEC+ are not keeping up with the past output commitments because most members have no spare capacity primarily due to the lack of investment. Some estimates suggest that something closer to half of the 648k barrels a day will likely be produced, which is still shy of the previous agreements. Also, the European effort to curb its demand for Russian oil, despite the modest and necessary compromises is seen exacerbating an already tight market. In addition, US oil inventories have fallen by almost 10 mln barrels over the past three weeks, the longest drawdown this year. The re-opening of Shanghai and easing of restrictions in Beijing are expected to boost Chinese demand for crude too.

The eurozone final PMI disappointed. The preliminary German and French service and composite PMI were revised lower. Italy missed forecasts. Spain surprised on the upside, and in this case, it means that the composite was unchanged from April (at 55.7). The aggregate service PMI was revised to 56.1 from 56.3 and 57.7 previously. It is the first decline since January. The composite PMI stands at 54.8, slightly lower than the preliminary, but off from the 55.8 reading in April. This year, the EMU composite PMI has been alternating between gains and declines. It stood at 53.3 at the end of last year. 

There are a few other high-frequency data points to note. First, Germany's April trade figures showed a rebound in exports (4.4% month-over-month) after a 3% drop in March. Economists had expected imports to fall by 2% but instead they rose by 3.1% on the heels of a 3.2% increase in March. The trade balance rose to 3.5 bln euros from a revised 1.9 bln surplus in April (initially 3.2 bln). The surge in energy prices has seen a dramatic deterioration of the notorious German trade surplus. This year it has averaged 5.8 bln euros a month. In the first four months of last year, the surplus averaged almost 17.0 bln euros. French industrial output in April slipped by 0.1%. Economists had looked for a small gain after a 0.5% decline in March (revised to a 0.4% fall). Manufacturing output fell by 0.4%. It is the third consecutive contraction in output. Finally, the aggregate retail sales collapsed by 1.3%. German and French figures had hinted at a disappointment with economists (median in Bloomberg's survey) looking for a small increase. That said, March's 0.4% decline was revised away to stand at a 0.3% increase.

The euro recovered smartly yesterday. After slumping by about 1.3 cents Tuesday and Wednesday, it jumped nearly 1% yesterday to $1.0750. It settled above Wednesday's high and follow-through buying today lifted it to almost $1.0765. The week's high, set Monday, was slightly above $1.0785. The $1.08 area offers formidable resistance. It has not been above there since April 25. Initial support is seen near $1.0740, but it probably takes a break of the $1.0680 area to push some late euro longs to the sidelines. The more than four-cent rally off the mid-May lows is stretching the momentum indicators, but the risk of a hawkish hold by the ECB next week may keep the single currency supported. UK markets are still closed for the holiday today. Sterling is in a narrow range of a little less than a third of a cent above $1.2560. Like the euro, it snapped back yesterday after slipping in the previous two sessions. Last Friday, sterling poked above $1.2665 but has not seen it this week. Still, it had traded above $1.26 for five sessions through the middle of the week. Sterling has rallied a nickel off the mid-May lows, leaving it stretched. The Slow Stochastic has turned down. The MACD does not look far behind. 

America

The December Fed funds futures were not persuaded that the big miss on the ADP private sector jobs report was particularly meaningful. The implied yield edged slightly higher yesterday. It was the third consecutive increase for a cumulative increase of about 15 bp. It had fallen 10 bp last week. The dollar and equities seemed to have traded like the Fed was closer to breaking something and would not be able to hike rates as much as it may wish. Does the ADP report contain useful data?  Yes, over the longer-term, it tracks the non-farm payroll report. No, in the short run, the fit is not tight. In 2021, the ADP reported average monthly private sector payroll growth of 573k. The BLS figures were closer to 525k. This is fairly good for a time series that is notoriously difficult to forecast. However, in the short run the gap can be substantial. Through April, the ADP average was 395k, while the BLS average was 507k. The ISM survey warned manufacturing employment slowed, but ADP estimated that the goods-producing sector added 24k. The ADP report warned that small businesses were finding its especially difficult to recruit and retain employees. Businesses with less than 50 employees lost 91k jobs, and for four months, companies with 20 or fewer employees have reported declines. Large businesses, which the BLS report may do a better job of tracking, gained 219k positions, according to the ADP survey.

The Federal Reserve wants the labor market to moderate, and it thinks it can achieve this without much of a rise in the unemployment rate, according to official comments and the Summary of Economic Projections (dot plot). Despite what appears to be widespread criticism of this view, the median forecast in Bloomberg's survey seems to concur. It has a 3.5% unemployment forecast for next year and CPI and the PCE deflator at 3%, and the Fed funds rate at 3.1%. Chair Powell has noted more than once that while its inflation target can be best expressed by the PCE deflator, there are many dimensions to the labor market. The failure of the higher wages and economic re-opening to boost the participation rate may be a factor encouraging tighter policy. Also, hourly earnings may not be the best gauge of wage pressure but it is handy and timely report. Average hourly earnings have risen by 0.4% on average this year, twice the average in the first four months last year. Recall that average hourly earnings rose at an average year-over-year pace of 3.2% in Q4 19. It was 5.4% in Q1 22.

A day after the Bank of Canada hiked its target rate by 50 bp for the second time and committed to further hikes, possibly in larger increments, going forward, Deputy Governor Beaudry pressed the case. He opened the door to hiking rates beyond the 2%-3% neutral range. He acknowledged that inflation is much higher than expected. The year-end rate in the swaps market rose almost seven basis points to poke above 3% for the first time in nearly a month. The peak of 3.05% was actually recorded on April 22. 

The US dollar posted an outside down day against the Canadian dollar. It first rose above Wednesday's high and then reversed and closed below Wednesday's low. It began the week above CAD1.27 and now, with the help of follow-through selling, has held below CAD1.26 today, where an option for $460 mln expires today. Since mid-May, the greenback has fallen by nearly 4%. The momentum indicators are stretched but have not turned. The greenback had fallen to two-year lows against the Mexican peso (~MXN19.4135) at the start of the week and bounced to around MXN19.7715 in the middle of the week. Yesterday's pullback returned it to the MXN19.5250 area. The dollar is finding support near there today. The momentum indicators are mixed. The MACD is falling but overextended while the Slow Stochastic has turned higher. 

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