Rate Whiplash After June Jobs Report
What You Missed: Interest rates climbed last week following 2 previous consecutive weekly declines. The reversal higher in rates was largely due to the market’s reassessment of the Fed’s determination to address broad and potentially latent inflationary pressures. Adding to the upward rate path was some stability within the equity markets which led to some shifting of flows out of U.S. Treasuries (USTs) back into riskier assets. Friday’s better than expected US June employment report added further to the upward rate pressure. Last week’s climb in rates initially got underway Wednesday ahead of the release of the minutes of the Fed’s June 14-15 policy meeting.
For the week, 2 and 5-yr UST yields increased a respective 27 and 25 bps to 3.11% and 3.12%. Out the curve, 10 and 30-yr yields rose 20 and 14 bps to 3.08% and 3.24%. Two to 30-yr rates ended the week at their highest levels in a week and a half and near their average of the past 4 weeks.
The recent end-of day high-mark for UST yields past 1-yr remains June 14th … the start of the Fed’s June policy meeting that concluded with a rare 75 bps hike in the Fed funds target the following day to its current 1.50% – 1.75% range. At the front of the yield curve, 3-month T-bill rates ended this past week at 1.88%, a new post-Covid closing high (highest since Sept 2019), while 3-month Term SOFR (CME) ended Friday at 2.24%, up ~ 13 bps on the week.
Implied interest rate volatility for USTs peaked early last week at the highest levels seen since Covid hit. Volatility did moderate somewhat as the days wore on to end Friday nearly unchanged on the week. Rate volatility, a key component to the cost of interest rate caps, is being kicked around by some of the manic features of the current rate environment. In recent weeks, sentiment has vacillated between identifying whether recession or inflation is the greater threat for the rate outlook. By the end of last week, inflation worries again took the lead which was the opposite of where the focus stood at the end of June. The jumpy rate environment, and its residual impact on rate volatility, is at the epicenter of absorbing the market’s shifting conviction over which threat will dominate. For the foreseeable future, we expect the unacceptable inflation backdrop to overshadow economic growth concerns as the July Fed rate decision is still over 2 weeks away.
Last Thursday, 2 voting members of the Fed’s FOMC indicated that they would support raising the Fed funds target by 75 bps at the upcoming July 26-27 FOMC policy meeting. Fed governor Christopher Waller reiterated that inflation was “just too high” while St. Louis Fed President James Bullard said he remains focused on getting the Fed’s target rate to 3.5% by the end of the year. And on Friday Atlanta Fed’s Raphael Bostic, currently a non-voting FOMC member, said he fully supported a 75 bps rate hike later this month. By the end of last week, the implied yield on the Dec 2022 Fed funds futures contract had risen to 3.40%, up 14 bps for the week. As of last Friday’s market close, the highest implied yield for Fed funds futures was 3.60%, seen for the April 2023 contract. Those expectations had exceeded 4.00% back in mid-June before recession concerns intensified.
The Fed minutes from the June 14-15 FOMC meeting, released last Wednesday, showed a relatively strong amount of agreement among Committee members supporting June’s 75 bps rate hike. There’s little doubt that as economic growth concerns build, a fierce debate over the magnitude of subsequent rate hikes will be ongoing within the FOMC. All said, the public “Fed speak” gathered since the mid-June Fed rate hike suggests the Committee is prepared to risk a recession as a tradeoff to bring down inflation. For the foreseeable future, the rate environment will continue to confront these conflicting forces.
Some key sentiment drivers were looking up last week. As rates climbed higher through last Friday, the U.S. equity market managed to eke out a gain. The S&P 500 added 1.9% for the week, not a trivial outcome given the broader sentiment shift that took place as markets refocused again on the possibility of another 75 bps U.S. rate hike on July 27. More broadly, the market capitalization of the public U.S. equity market ended last week approaching $39 Tn, a gain of approximately $0.9 Tn on the week. With this measure of accumulated wealth having fallen from $48.5 Tn at y/e 2021, any uptick in stocks is likely to be favorable for overall consumer sentiment which has been beaten up this year badly amid falling stocks, higher inflation, and particularly gas and food prices.
The U.S. dollar (USD) continued to strengthen last week. The DXY currency index reached 107.13 last Thursday, its highest closing level October 2002. The key contributors to this development, which gives U.S. consumers more purchasing power for imports, are the increased pace of U.S. interest rate hikes and the continued decline of the euro currency and the Japanese yen. Last Thursday the euro fell to $1.016, its lowest closing level against the U.S. dollar since December 2002 amid a widening interest rate gap between the U.S. and the Euro area. With a 1 to 1 exchange rate parity in sight, the focus on a 50-bps rate hike by the European Central Bank (ECB) to confront inflation later this month (July 21 ECB meeting) has intensified. While a more hawkish ECB could soon cap the USD’s strength, a shift in monetary policy by Japan’s central bank could notably reverse the dollar’s fortunes. The Japanese yen closed Friday at JPY 136.1, a near 24-year low against the USD. The Bank of Japan (BoJ), with its ultra-low interest rate policy, has become increasingly out of sync with global central banks. Despite the reality that the BoJ is deeply dug into its ultra-easy monetary policy stance, the yen’s deep decline since March, combined with an increased pace of global rate tightening, should at a minimum continue to lift speculation over the possibility an eventual policy shift by the BoJ. Over time, this likely leaves the USD more vulnerable to weaken (than strengthen) which could add further to market volatility.
Crude oil prices fell about $3 last week, with WTI briefly below $100/bbl Tuesday and Wednesday, before closing out the week just shy of $105/bbl. Arguably more significant, U.S. retail gasoline prices (national average regular prices tallied by AAA) continued their descent last week dropping roughly 12 cents/gal. Since reaching a record high price of $5.02 on June 13th, prices have fallen 32 cents/gal to $4.70 last Friday. Although prices are only back down to about where they began June, the reversal is providing some unexpected economic relief. Since the level and direction of gasoline prices are a major contributor to headline CPI, impact consumer sentiment, and have political consequences, the latest price drop is significant. If price declines are sustained or drop further, this should certainly help in the Fed’s efforts to turn back the growing inflation mindset hanging over the economy. Unfortunately supply conditions are not abundant and geopolitical risks are significant, and potentially unstable, suggesting energy prices remain quite vulnerable to greater volatility.
Elsewhere, while grain commodity prices climbed last week, prices remain at levels that are unlikely to add to additional inflation pressures and perhaps even bring about some price relief if sustained. Although corn prices rose for a second consecutive week, prices ended last week about flat to the 3-month average. Although wheat prices climbed last week, they ended Friday 38% below the surge price that unfolded after the war on Ukraine began in February. Friday’s closing price of $879 on the CBT Wheat futures front contract was nearly 17% below its 3-month average price. While copper prices ended Friday 28% below their early March 2022 peak, they rose modestly last week. Why you should care about commodity prices: The industrial metal’s relative weakness should help alleviate some inflation pressures but is more frequently aligned with anticipating economic sluggishness than as an inflation/deflation signal.
The cushion that may likely absorb some economic pain
Friday’s release of June’s US employment situation beat consensus expectations and reinforced the need for the Fed to worry less about its maximum employment policy mandate right now and more about seeking price stability, its other key mandate. June’s 372k nonfarm payroll gain combined with previous revisions, beat expectations by approximately 100k. For H1 ‘22, monthly NF payroll gains have averaged 457k and for Q2 ‘22, 375k suggesting the U.S. Labor market is holding up quite well so far amid the Fed’s rate hikes. The unemployment rate held at its recent low of 3.6% for a 4th consecutive month while the YoY change in average hourly earnings held above 5% for a sixth straight month. The monthly change in average hourly earnings, however, was a 0.3% gain reflecting some slippage compared to late last year/early this year. Key issue here is that inflation is clearly outpacing wage gains … a reality that should incentivize the Fed to stay the course on continuing to hike rates and fulfill its price stability mandate.
The other key data on the U.S. job market last week was the Labor Department’s May job openings report released last Wednesday. Although U.S. job openings fell by 427k to 11.25 mn, the outcome exceeded consensus expectations and remained near March’s record 11.86 mn. Despite May’s decline, the latest level of job openings is still extremely high. Consider that the number of May job openings was also higher than any level seen prior to last December. According to the June employment report released last Friday, there were 5.91 mn unemployed, essentially unchanged since March. Before covid hit in Feb 2020, there were 5.72 mn unemployed workers in the U.S.
While the job market has largely recovered its covid-effect amid dislocations and reshuffling, the latest figures between these 2 job market reports (by the Labor Department) suggest there are approximately 1.9 jobs available in this country for every unemployed person. Not too shabby in theory and very suggestive of a deep (theoretical) cushion in place for U.S. employment conditions to hold up overall in the event the Fed’s policy tightening triggers a recession.
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What to Watch This Week: The one-two punch is here. With June employment data out of the way, the overwhelming focus now shifts to June U.S. inflation data to be released this Wednesday. The Bloomberg consensus anticipates that the headline CPI rose 8.8% from a year ago and climbed 1.1% from May (ouch). If these expectations materialize, it would reflect slightly greater price pressures than reported last month for May (+8.6% yoy and +1.0% mom). May’s CPI release on June 10th was quite an event, for the market and no doubt the Fed, given that consensus expectations were exceeded. Heading into that report last month there was growing speculation that price pressures would begin to moderate. Wasn’t so. The after effect helped push 2 to 30-yr US Treasury yields to post-Covid highs on June 14th (this cycle’s high) and no doubt closed the deal for the FOMC to deliver its first 75 bps rate hike since 1994 on June 15th.
Also of note this week on the inflation front, U.S. wholesale prices (PPI) for June will be reported Thursday. Consensus expectations call for a 10.7% yoy annual headline outcome which would be the 7th consecutive month > 10%. On Friday, June import prices are due to be reported and an annual yoy headline outcome of 11.4% is anticipated.
Friday will also see important U.S. data on retail sales for June and consumer sentiment (U. of Michigan) for July (a preliminary look). The price of gasoline factors into both of these releases. Retail gasoline prices (national average for regular) peaked on June 13th. Overall, higher retail gasoline prices on average for last month are expected to lift the June headline retail sales figures, however, the focus will likely be on the core sales measure (ex-gas and autos) as it arguably presents a clearer view of spending trends. No increase is anticipated by the consensus. As gasoline prices have slid since mid-June, we look to see what effect, if any, this might have had on U.S. consumer sentiment in the U. of Michigan release. While the consensus does not anticipate consumer sentiment having improved so far this month, we anticipate that consumer sentiment will soon show some improvement in the event retail gasoline prices stabilize.
Big Picture: A large increase in June’s U.S. CPI is expected this Wednesday establishing a more certain path for another 75 bps rate hike at the conclusion of the upcoming FOMC meeting on July 27th.. Last Friday’s better than expected jobs report clears the way for the Fed to act boldly given that inflation remains uncomfortably high. Key economic concerns over recession and the Fed’s role in bringing that on have been largely pushed aside by June’s mostly healthy U.S. employment situation.
For the week ahead, the path of least resistance for U.S. interest rates looks to be somewhat higher. Clearly, reports on inflation this week will dominate the focus and may likely influence both rate movement and volatility, however, we do not anticipate U.S. Treasury yields climbing back to their June 14th highs this week. Q2 corporate earnings are about to be released and the news will remain a market feature for some time. Margin pressures and top line momentum will be the big stories here and will most likely produce some equity market and rate volatility.
Beyond this week’s CPI but ahead of the July 27th FOMC decision, we are very focused on the June housing data to be released July 19-20. We mention this now because of how easy it is for this market to lose sight of some key but important underpinnings. What’s very clear here is that much like with the employment situation, there are very notable imbalances that need to be the primary focus of this market. As we saw last week with U.S. employment, there are many more jobs available than there are unemployed persons and similarly with housing, there is a housing shortage. It’s real. We don’t have enough homes for the demand seen. Ultimately, this sets a floor on rents and home prices. The bottom line is that the Fed has spoken loudly and pretty clearly about continuing to aggressively pursue its price stability mandate. The Fed is not fooling around here. If the job market and the housing sector are unlikely to face serious setbacks amid the higher cost of money, which is what we’ve seen so far, then the possibility of a 3.50% – 4.00% Fed funds rate outcome should not be ignored.
In the meantime, for borrowers, flexibility in interest expense is critical. Who is helping you avoid the potholes that lie ahead?
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Source: Bloomberg Professional