Will the Fed’s payrolls pillar crack?

  • ‘Bond markets rally as investors cheer Lagarde’s ECB nomination’.  International Monetary Fund (IMF) Chief Christine Lagarde was an unexpected nomination for the European Central Bank (ECB) President post, to succeed Mario Draghi who will vacate the position in October. Her prior views endorsing extraordinary ECB policy has led bond markets to rally in anticipation of continued easy policy. (Financial Times)
  • ‘Minister anticipates own sacking in speech attacking populists’. Sensing his imminent departure, Justice Secretary David Gauke took to the podium to deliver a speech about the increasingly populist nature of the ruling political class, and deterioration in public trust in government institutions. (The Guardian)

Unsurprising surprise

The Bank of England’s (BoE) wait-and-see monetary policy stance may soon take a dovish turn following a deterioration in UK economic data. For months, the UK central bank has kept rates on hold while Prime Minister Theresa May tried to get her Brexit deal approved by Parliament. The failure of the UK government to find consensus forced the UK and the EU to delay the Brexit deadline until 31st October 2019.

Since the initial Brexit deadline, increased uncertainty and waning global growth have really begun to weigh on the UK economy. In the past few weeks, UK data has significantly fallen short of expectations, as indicated by Citigroup’s UK Economic Surprise Index. Markit’s Composite Purchasing Managers’ Index (PMI)—a measure of the UK manufacturing, construction, and service sectors—established the weakest reading since 2009, excluding a one-month blip following the EU referendum. This is a level consistent with a quarterly Gross Domestic Product (GDP) contraction of 0.2%.

The BoE already has the dark cloud of Brexit hanging over it as a disruptive departure from the EU remains on the cards. If the central bank is forced to ease policy before the October deadline, it weakens its capacity to provide further stimulus. This could tempt more unconventional policy intervention, the effectiveness of which remains controversial among economists.

Bottom line: Pressure is building on Carney to follow other central banks in easing monetary policy following weak economic data. The trade-weighted Pound Index has already fallen 5.0% since the initial Brexit deadline, and the trend looks set to continue, especially if the BoE acts sooner than policymakers have led us to believe

Can anything delay a July Fed cut?

The next Federal Reserve interest rate decision is due on July 31st, and for weeks, markets have been treating a rate cut as a sure thing. The recent dovish tilt from the Fed—along with other major central banks—has resulted in a global bond rally, which indicates markets expect more significant policy easing. Current bond prices indicate a 100% chance of a 25-basis point rate cut in July.

In a survey conducted by BMO Capital Markets this week, respondents gave a 20% chance that the Fed does not lower rates, which is at odds with market pricing. In the coming weeks, several data releases will shape the Fed’s policy decision, meaning this week’s payrolls report takes on increased significance. A figure above the predicted 160k and no downward revision of last month’s 75k and policymakers may push for a rate hold. After all, labour market strength has been the pillar of the Fed’s latest tightening cycle. Likewise, strong inflation and retail sales data would bring back some belief in the resilience of the US economy.

Bottom line: If payrolls rebound, market expectations of a July ‘insurance-cut’ may rapidly shift. A pullback in bonds would also test the longevity of the equity-rally. It may take a string of strong data and no more unexpected trade threats out of the White House to prevent the Fed easing, but it’s not yet a sure thing.

GBP/USD

The Pound continues a modest downward trend, marking fresh lows each day. Meanwhile, the Dollar trades flat in advance of the 4th July US public holiday. The pair is trending towards mid-June lows and the bottom of the range.

GBP/EUR

Since the pullback in the Euro on Monday, little has happened. As a pair, GBPEUR continues to trade lower towards the bottom of the seven-month trading range, and December 2018 lows. There is little economic data out today, which means news headlines are likely to dictate any movement until tomorrow’s US Non-Farm Payrolls data closes the week.

EUR/USD

Monday’s pullback of the common currency broke below the 200-day moving average, but little has occurred since, and with empty data calendars, the pair seems well supported at the 100-day moving average. There is little impetus for a move until tomorrow.